Document/ExhibitDescriptionPagesSize 1: 10-K Annual Report HTML 3.41M
2: EX-4.1.A Ex-4.1.A: Indenture 100 349K
3: EX-4.1.C Ex-4.1.C: Fifth Supplemental Indenture HTML 89K
4: EX-4.4.A Ex-4.4.A: Junior Subordinated Indenture 79 372K
10: EX-10.10 Ex-10.10: Amendment to Bank One Corporation HTML 41K
Director Stock Plan
11: EX-10.12 Ex-10.12: Bank One Corporation Stock Performance HTML 42K
Plan
12: EX-10.13 Ex-10.13: Bank One Corporation Supplemental HTML 32K
Savings and Investment Plan
13: EX-10.14 Ex-10.14: Banc One Corporation 1989 Stock 14 69K
Incentive Plan
14: EX-10.15 Ex-10.15: Banc One Corporation 1995 Stock 10 51K
Incentive Plan
15: EX-10.20 Ex-10.20: Form of Long-Term Incentive Plan Terms HTML 58K
and Conditions for Stock Appreciation
Rights
16: EX-10.21 Ex-10.21: Form of Long Term Incentive Plan Terms HTML 59K
and Conditions for Operating Committee
Member Stock Appreciation Rights
17: EX-10.22 Ex-10.22: Form of Long Term Incentive Plan Terms HTML 57K
and Conditions for Restricted Stock
Units
18: EX-10.23 Ex-10.23: Form of Long-Term Incentive Plan Terms HTML 60K
and Conditions for Operating Committee
Restricted Stock Units
5: EX-10.3 Ex-10.3: Post-Retirement Compensation Plan for 5 24K
Non-Employee Directors
6: EX-10.4 Ex-10.4: 2005 Deferred Compensation Program HTML 89K
7: EX-10.7 Ex-10.7: Excess Retirement Plan HTML 45K
8: EX-10.8 Ex-10.8: 1995 Stock Incentive Plan 16 62K
9: EX-10.9 Ex-10.9: Executive Retirement Plan HTML 38K
19: EX-12.1 Ex-12.1: Computation of Ratio of Earnings to Fixed HTML 25K
Charges
20: EX-12.2 Ex-12.2: Computation of Ratio of Earnings to Fixed HTML 26K
Charges and Preferred Stock Dividend
Requirements
21: EX-21.1 Ex-21.1: List of Subsidiaries of Jpmorgan Chase & HTML 145K
Co.
22: EX-23.1 Ex-23.1: Consent of Independent Registered Public HTML 13K
Accounting Firm
23: EX-31.1 Ex-31.1: Certification HTML 18K
24: EX-31.2 Ex-31.2: Certification HTML 18K
25: EX-32 Ex-32: Certification HTML 14K
Principal Protected Notes Linked to the Nasdaq-100 Index® Due December 22, 2009
The NYSE Alternext U.S. LLC
Principal Protected Notes Linked to the S&P 500® Index Due November 30, 2009
The NYSE Alternext U.S. LLC
Principal Protected Notes Linked to the Dow Jones Industrial AverageSM due March 23, 2011
The NYSE Alternext U.S. LLC
Medium Term Notes Linked to a Basket of Three International Equity Indices Due August 2, 2010
The NYSE Alternext U.S. LLC
Securities registered pursuant to Section 12(g) of the Act: none
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined
in Rule 405 of the Securities
Act. x Yes o No
Indicate by check mark if the Registrant is not required to file reports pursuant to Section
13 or Section 15(d) of the Act. o Yes x No
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required
to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes o No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation
S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate
by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.
See the definitions of “large accelerated filer,”“accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
x Large accelerated filer
o Accelerated filer
o Non-accelerated filer (Do not check if a smaller reporting company)
o Smaller reporting company
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). o Yes x No
The aggregate market value of JPMorgan Chase & Co. common stock held by non-affiliates of
JPMorgan Chase & Co. on June 30, 2008 was approximately $117,255,349,362.
Number of shares of common stock outstanding on January 31, 2009: 3,757,923,192
Overview
JPMorgan Chase & Co. (“JPMorgan Chase” or the “Firm”) is a financial
holding company incorporated under Delaware law in 1968. JPMorgan
Chase is one of the largest banking institutions in the United States of
America (“U.S.”), with $2.2 trillion in assets, $166.9 billion in stockholders’ equity and operations in more than 60 countries.
JPMorgan Chase’s principal bank subsidiaries are JPMorgan Chase
Bank, National Association (“JPMorgan Chase Bank, N.A.”), a
national banking association with U.S. branches in 23 states, and
Chase Bank USA, National Association (“Chase Bank USA,
N.A.”), a
national banking association that is the Firm’s credit card–issuing
bank. JPMorgan Chase’s principal nonbank subsidiary is J.P. Morgan
Securities Inc. (“JPMorgan Securities”), the Firm’s U.S. investment
banking firm. The bank and nonbank subsidiaries of JPMorgan Chase
operate nationally as well as through overseas branches and subsidiaries, representative offices and subsidiary foreign banks.
The Firm’s website is www.jpmorganchase.com. JPMorgan Chase
makes available free of charge, through its website, annual reports
on Form 10-K, quarterly reports on Form 10-Q and current reports on
Form 8-K, and any amendments to those reports filed or furnished
pursuant to Section 13(a) or Section 15(d) of the Securities Exchange
Act of 1934, as soon as reasonably practicable after it electronically
files such material with, or furnishes such material to, the Securities
and Exchange Commission (the “SEC”). The Firm has adopted, and
posted on its website, a Code of Ethics for its Chairman and Chief
Executive Officer, Chief Financial Officer, Chief Accounting Officer and
other senior financial officers.
Business segments
JPMorgan Chase’s activities are organized, for management reporting
purposes, into six business segments, as well as Corporate/Private
Equity. The Firm’s wholesale businesses comprise the Investment
Bank, Commercial Banking, Treasury & Securities Services and Asset
Management segments. The Firm’s consumer businesses comprise the
Retail Financial Services and Card Services segments.
A description of the Firm’s business segments and the products and
services they provide to their respective client bases is provided in
the “Business segment results” section of Management’s discussion
and analysis of financial condition and results of operations
(“MD&A”), beginning on page 40 and in Note 37 on page 214.
Competition
JPMorgan Chase and its subsidiaries and affiliates operate in a highly competitive environment.
Competitors include other banks, brokerage firms, investment banking companies, merchant banks, hedge funds, insurance
companies, mutual fund companies, credit card companies, mortgage
banking companies, trust companies, securities processing companies, automobile
financing companies, leasing companies,
e-commerce and other Internet-based companies, and a variety of
other financial services and advisory companies. JPMorgan Chase’s
businesses generally compete on the basis of the quality and range
of their products and services, transaction execution, innovation and
price. Competition also varies based on the types of clients, customers, industries and geographies served. With respect to some of its geographies and products, JPMorgan Chase competes globally;
with respect to others, the Firm competes on a regional basis. The Firm’s ability to compete also
depends upon its ability to attract and retain its professional and other personnel, and on its
reputation.
The financial services industry has experienced
consolidation and convergence in recent years, as
financial institutions involved in a broad range of
financial products and services have merged and, in
some cases, failed. This convergence trend is
expected to continue. Consolidation could result in
competitors of JPMorgan Chase gaining greater
capital and other resources, such as a broader
range of products and services and geographic
diversity. It is likely that competition will
become even more intense as the Firm’s businesses
continue to compete with other financial
institutions that are or may become larger or
better capitalized, or that may have a stronger
local presence in certain geographies.
Supervision and regulation
The Firm is subject to regulation under state and
federal laws in the U.S., as well as the
applicable laws of each of the various
jurisdictions outside the U.S. in which the Firm
does business.
Recent legislation affecting the Firm: In response
to recent market and economic conditions, the
United States government, particularly the U.S.
Department of the Treasury (the “U.S.
Treasury”), the Board of Governors of the Federal
Reserve System (the “Federal Reserve”) and the
Federal Deposit Insurance Corporation (the “FDIC”), have
taken a variety of extraordinary measures designed
to provide fiscal stimulus, restore confidence in
the financial markets and to strengthen financial
institutions, including capital injections,
guarantees of bank liabilities and the acquisition
of illiquid assets from banks. In particular on
October 3, 2008 and February 17, 2009, the Emergency
Economic Stabilization Act of 2008 (the “EESA”) and
the American Recovery and Reinvestment Act of 2009
(the “ARRA”), respectively, were signed into law.
The EESA
and the ARRA, together with the U.S. Treasury’s Capital
Purchase Program (which provides for direct purchases by the U.S.
Treasury of equity of financial institutions)
contain provisions limiting the Firm’s ability to
pay dividends, purchase its own common stock, and
compensate selected officers and employees, among
other restrictions. For further information
regarding certain of the recent limitations
applicable to the Firm, see Regulatory Capital on
pages 71–73.
Other programs and actions taken include (1) the
U.S. Treasury’s Temporary Guarantee Program for
Money Market Funds, which is designed to guarantee
the share price of eligible money market funds that
apply to the program and pay a fee to
participate, (2) the Federal Reserve Bank of New
York’s Money Market Investor Funding Facility (the
“MMIFF”), which is designed to provide liquidity to
U.S. money market investors, (3) the Federal
Reserve’s Commercial Paper Funding Facility, which
is designed to provide liquidity to term funding
markets by providing a liquidity backstop to U.S.
issuers of commercial paper, (4) the Federal
Reserve’s Asset Backed Commercial Paper Money
Market Mutual Fund Liquidity Facility (the “AML Facility”),
which is designed to provide liquidity to money
market mutual funds under certain conditions by
providing funding to U.S. depository institutions
and bank holding companies secured by high-quality
asset-backed commercial paper they purchased from
those money market mutual funds, (5) the FDIC’s
Temporary Liquidity Guarantee Program (the “TLG
Program”), which enables the FDIC to temporarily
provide a 100% guarantee of the senior debt of all
FDIC-insured institutions and their holding
companies, as well as deposits in
noninterest-bearing transaction deposit
accounts, (6) the Federal Reserve’s
Primary Dealer Credit Facility (the
“PDCF”), which is designed to foster the financial
markets generally, was modified to expand the
eligible collateral to include any collateral
eligible for tri-party repurchase agreements, (7)
the Federal Reserve’s Term Securities Lending
Facility (the “TSLF”), which is designed to promote
liquidity in the financial markets for treasuries
and other collateral, was expanded to (a) include
all investment-grade debt securities as eligible
collateral for schedule 2 auctions and (b) increase
the frequency of schedule 2 auctions, (8) the
Federal Reserve’s adoption of an interim rule that
provides an exemption, until January 30, 2009, to
the Federal Reserve Act to allow insured depository
institutions to provide liquidity to their
affiliates for assets typically funded in the
tri-party repurchase agreement market, (9) the
Federal Reserve’s Term Auction Facility (the
“TAF”), which is designed to allow financial
institutions to borrow funds at a rate that is
below the discount rate, (10) the Federal Reserve’s
Term Asset-Backed Securities Loan Facility (the
“TALF”), which is designed to assist in the credit
markets in accommodating the credit needs of
consumers and small businesses by facilitating the
issuance of asset-backed securities and improving
the conditions for asset-backed securities more
generally, (11) the Federal Reserve’s announcement
that it will purchase up to $600 billion of direct
obligations of housing-related
government–sponsored enterprises (“GSEs”) and
mortgage-backed securities of GSEs, (12) the U.S.
Treasury’s Financial Stability Plan, which involves
(a) the creation of a public-private investment
fund of up to $1 trillion, (b) the expansion of the
TALF program up to $1 trillion under the consumer
and business lending initiative, and (c) the
creation of a financial stability trust for bank
investment and additional transparency, and (13)
President Obama’s Home Owner Affordability and
Stability Plan, which is intended to (a) provide
refinancing assistance for responsible homeowners
suffering from falling home prices, (b) a
comprehensive $75 billion homeowner stability
initiative, and (c) strengthen confidence in the
GSEs. The Firm is currently participating in certain of these
programs and may become a future participant in others of these
programs, or additional new programs established by the
U.S. government.
Permissible business activities: JPMorgan Chase
elected to become a financial holding company as of
March 13, 2000, pursuant to the provisions of the
Gramm-Leach-Bliley Act (“GLBA”). Under regulations
implemented by the Board of Governors of the
Federal
Reserve System (the “Federal Reserve Board”), if any
depository institution controlled by a financial
holding company ceases to meet certain capital or
management standards, the Federal Reserve Board may
impose corrective capital and/or managerial
requirements on the financial holding company and
place limitations on its ability to conduct the
broader financial activities permissible for
financial holding companies. In addition, the
Federal Reserve Board may require divestiture of
the holding company’s depository institutions if
the deficiencies
persist. The regulations also provide that if
any depository institution controlled by a
financial holding company fails to maintain a
satisfactory rating under the Community
Reinvestment Act (“CRA”), the Federal Reserve Board
must prohibit the financial holding company and its
subsidiaries from engaging in any additional
activities other than those permissible for bank
holding companies that are not financial holding
companies. At December 31, 2008, the
depository-institution subsidiaries of JPMorgan
Chase met the capital, management and CRA
requirements necessary to permit the Firm to
conduct the broader activities permitted under
GLBA. However, there can be no assurance that this
will continue to be the case in the future.
Financial holding companies and bank holding
companies are required to obtain the approval of
the Federal Reserve Board before they may acquire
more than five percent of the voting shares of an
unaffiliated bank. Pursuant to the Riegle-Neal
Interstate Banking and Branching Efficiency Act of
1994 (the “Riegle-Neal Act”), the Federal Reserve
Board may approve an application for such an
acquisition without regard to whether the
transaction is prohibited under the law of any
state, provided that the acquiring bank holding
company, before or after the acquisition, does not
control more than 10% of the total amount
of deposits of insured depository institutions in
the U.S. or more than 30% (or such
greater or lesser amounts as permitted under state
law) of the total deposits of insured depository
institutions in the state in which the acquired
bank has its home office or a branch.
Regulation by Federal Reserve Board under GLBA:
Under GLBA’s system of “functional regulation,” the Federal Reserve Board acts as an “umbrella
regulator, ” and certain of JPMorgan Chase’s
subsidiaries are regulated directly by additional
authorities based upon the particular activities
of those subsidiaries. JPMorgan Chase Bank, N.A.,
and Chase Bank USA, N.A., are regulated by the
Office of the Comptroller of the Currency
(“OCC”). See “Other supervision and regulation”
below for a further description of the regulatory
supervision to which the Firm’s subsidiaries are
subject.
Dividend restrictions: Federal law imposes
limitations on the payment of dividends by national
banks. Dividends payable by JPMorgan Chase Bank,
N.A. and Chase Bank USA, N.A., as national bank
subsidiaries of JPMorgan Chase, are limited to the
lesser of the
amounts calculated under a “recent earnings” test
and an “undivided profits” test. Under the recent
earnings test, a dividend may not be paid if the
total of all dividends declared by a bank in any
calendar year is in excess of the current year’s
net income combined with the retained net income of
the two preceding years, unless the national bank
obtains the approval of the OCC. Under the
undivided profits test, a dividend may not be paid
in excess of a bank’s “undivided profits.” See Note
29 on page 199 for the amount of dividends that the
Firm’s principal bank subsidiaries could pay, at
January 1, 2009 and 2008, to their respective bank
holding companies without the approval of their
banking regulators.
In addition to the dividend restrictions described
above, the OCC, the Federal Reserve Board and the
FDIC have authority to prohibit or limit the
payment of dividends by the banking organizations
they supervise, including JPMorgan Chase and its
bank and bank holding
company subsidiaries, if, in the banking
regulator’s opinion, payment of a dividend would
constitute an unsafe or unsound practice in light
of the financial condition of the banking
organization.
For a discussion of additional dividend
restrictions relating to the Capital Purchase
Program, see Capital Purchase Program on page 72.
Capital requirements: Federal banking regulators
have adopted risk-based capital and leverage
guidelines that require the Firm’s
capital-to-assets ratios to meet certain minimum
standards.
The risk-based capital ratio is determined by
allocating assets and specified off–balance sheet
financial instruments into four weighted
categories, with higher levels of capital being
required for the categories perceived as
representing greater risk. Under the guidelines,
capital is divided into two tiers: Tier 1 capital
and Tier 2 capital. The amount of Tier 2 capital
may not exceed the amount of Tier 1 capital. Total
capital is the sum of Tier 1 capital and Tier 2
capital. Under the guidelines, banking
organizations are required to maintain a total
capital ratio (total capital to risk-weighted
assets) of 8% and a Tier 1 capital ratio of 4%.
The federal banking regulators also have
established minimum leverage ratio guidelines. The
leverage ratio is defined as Tier 1 capital divided
by adjusted average total assets (which reflects
adjustments for disallowed goodwill and certain
intangible assets). The minimum leverage ratio is 3%
for bank holding companies that are considered
“strong” under Federal Reserve Board guidelines or
which have implemented the Federal Reserve Board’s
risk-based capital measure for market risk. Other
bank holding companies must have a minimum leverage
ratio of 4%. Bank holding companies may be expected
to maintain ratios well above the minimum levels,
depending upon their particular condition, risk
profile and growth plans.
The minimum risk-based capital requirements adopted
by the federal banking agencies follow the Capital
Accord of the Basel Committee on Banking
Supervision. In 2004, the Basel Committee published
a revision to the Accord (“Basel II”). U.S. banking
regulators published a final Basel II rule in
December 2007 which requires JPMorgan Chase to
implement Basel II at the holding company level, as
well as at certain of its key U.S. bank
subsidiaries. For additional information regarding
Basel II, see Regulatory capital on page 72.
Effective January 1, 2008, the SEC authorized
JPMorgan Securities to use the alternative method
of computing net capital for broker/dealers that
are part of Consolidated Supervised Entities as
defined by SEC rules. Accordingly, JPMorgan
Securities may calculate deductions for market risk
using its internal market risk models. For
additional information regarding the Firm’s
regulatory capital, see Regulatory capital on pages
71–73 and Note 30 on pages 200–201.
Federal Deposit Insurance Corporation Improvement Act:
The Federal Deposit Insurance Corporation
Improvement Act of 1991 (“FDICIA”) provides a
framework for regulation of depository institutions
and their affiliates, including parent holding
companies, by their federal banking regulators.
As part of that framework, the FDICIA requires the relevant
federal banking regulator to take “prompt
corrective action” with respect to a depository
institution if that institution does not meet
certain capital adequacy standards.
Supervisory actions by the appropriate federal
banking regulator under the “prompt corrective
action” rules generally depend upon an
institution’s classification within five capital
categories. The regulations apply only to banks and
not to bank holding companies such as JPMorgan
Chase; however, subject to limitations that may be
imposed pursuant to GLBA, the Federal Reserve Board
is authorized to take appropriate action at the
holding company level, based upon the
undercapitalized status of the holding company’s
subsidiary banking institutions. In certain
instances relating to an undercapitalized banking
institution, the bank holding company would be
required to guarantee the performance of the
undercapitalized subsidiary’s capital restoration
plan and might be liable for civil money damages
for failure to fulfill its commitments on that
guarantee.
Deposit Insurance: Under current FDIC regulations,
each depository institution is assigned to a risk
category based on capital and supervisory measures.
A depository institution is assessed insurance
premiums by the FDIC based on its risk category and
the amount of deposits held. During the fourth
quarter 2008, the amount of FDIC insurance coverage
for insured deposits was increased under the
EESA, generally from $100,000 per depositor to
$250,000 per depositor, and pursuant to the
Firm’s participation in the FDIC’s TLG Program insured deposits held in
noninterest-bearing transaction accounts are now
fully insured. These increases in insurance coverage are
scheduled to end on December 31, 2009. The FDIC has
stated its intention, as part of its proposed
Deposit Insurance Fund
restoration plan, to increase deposit insurance
assessments. On January 1, 2009, the FDIC increased
its assessment rates, and has proposed further rate
increases and changes to the current risk-based
assessment framework. In addition, as a result of the Firm’s
participation in the TLG Program, the Firm is required to pay
additional insurance premiums to the FDIC in an amount equal to an
annualized 10-basis points on balances in noninterest-bearing
transaction accounts that exceed the $250,000 deposit insurance limit,
determined on a quarterly basis.
Powers of the FDIC upon insolvency of an insured
depository institution: An FDIC-insured depository
institution can be held liable for any loss
incurred or expected to be incurred by the FDIC in
connection with another FDIC-insured institution
under common control with such institution being
“in default” or “in danger of default” (commonly
referred to as “cross-guarantee” liability). An FDIC
cross-guarantee claim against a depository
institution is generally superior in right of
payment to claims of the holding company and its
affiliates against such depository institution.
If the FDIC is appointed the conservator or
receiver of an insured depository institution upon
its insolvency or in certain other events, the
FDIC has the power: (1) to transfer any of the
depository institution’s assets and liabilities to
a new obligor without the approval of the
depository institution’s creditors; (2) to enforce
the terms of the depository institution’s
contracts pursuant to their terms; or (3) to
repudiate or disaffirm any contract or lease to
which the depository institution is a party, the
performance of which is determined by the FDIC to
be burdensome and the disaffirmation or
repudiation of which is determined by the FDIC to
promote the orderly administration of the
depository institution. The above provisions would
be applicable to obligations and liabilities of
JPMorgan Chase’s subsidiaries that are insured
depository institutions, such as JPMorgan Chase
Bank, N.A., and Chase Bank USA, N.A., including,
without limitation, obligations under senior or
subordinated debt issued by
those banks to investors (referred to below as
“public note holders”) in the public markets.
Under federal law, the claims of a receiver of an
insured depository institution for administrative
expense and the claims of holders of U.S. deposit
liabilities (including the FDIC, as subrogee of the
depositors) have priority over the claims of other
unsecured creditors of the institution, including
public noteholders and depositors in non-U.S.
offices, in the event of the liquidation or other
resolution of the institution. As a result, whether
or not the FDIC would ever seek to repudiate any
obligations held by public noteholders or
depositors in non-U.S. offices of any subsidiary of
the Firm that is an insured depository institution,
such as JPMorgan Chase Bank, N.A., or Chase Bank
USA, N.A., such persons would be treated
differently from, and could receive, if anything,
substantially less than the depositors in U.S.
offices of the depository.
The Bank Secrecy Act: The Bank Secrecy Act (“BSA”)
requires all financial institutions, including
banks and securities broker-dealers, to, among
other things, establish a risk-based system of
internal controls reasonably designed to prevent
money laundering and the financing of terrorism.
The BSA includes a variety of recordkeeping and
reporting requirements (such as cash and suspicious
activity reporting), as well as due
diligence/know-your-customer documentation
requirements. The Firm has established a global
anti-money laundering program in order to comply
with BSA requirements.
Other supervision and regulation: Under current
Federal Reserve Board policy, JPMorgan Chase is
expected to act as a source of financial strength
to its bank subsidiaries and to commit resources to
support these subsidiaries in circumstances where
it might not do so absent such policy. However,
because GLBA provides for functional regulation of
financial holding company activities by various
regulators, GLBA prohibits the Federal Reserve
Board from requiring payment by a holding company
or subsidiary to a depository institution if the
functional regulator of the payor objects to such
payment. In such a case, the Federal Reserve Board
could instead require the divestiture of the
depository institution and impose operating
restrictions pending the divestiture.
The bank subsidiaries of JPMorgan Chase are subject
to certain restrictions imposed by federal law on
extensions of credit to, and certain other
transactions with, the Firm and certain other
affiliates, and on investments in stock or
securities of JPMorgan Chase and those affiliates.
These restrictions prevent JPMorgan Chase and other
affiliates from borrowing from a bank subsidiary
unless the loans are secured in specified amounts.
See Note 29 on page 199.
The Firm’s banks and certain of its nonbank
subsidiaries are subject to direct supervision and
regulation by various other federal and state
authorities (some of which are considered
“functional regulators” under GLBA). JPMorgan
Chase’s national bank subsidiaries, such as
JPMorgan Chase Bank, N.A., and Chase Bank USA,
N.A., are subject to supervision and regulation by
the OCC and, in certain matters, by the Federal
Reserve Board and the FDIC. Supervision and
regulation by the responsible regulatory agency
generally includes comprehensive annual reviews of
all major aspects of the relevant
bank’s business and condition, and imposition of
periodic reporting requirements and limitations on
investments, among other powers.
The Firm conducts securities underwriting, dealing
and brokerage activities in the U.S. through
JPMorgan Securities and other broker-dealer
subsidiaries, all of which are subject to
regulations of the SEC, the Financial Industry
Regulatory Authority and the New York Stock
Exchange, among others. The Firm conducts similar
securities activities outside the U.S. subject to
local regulatory requirements. The operations of
JPMorgan Chase mutual funds also are subject to
regulation by the SEC.
The Firm has subsidiaries that are members of
futures exchanges in the U.S. and abroad and are
registered accordingly. In the U.S., three
subsidiaries are registered as futures commission
merchants, with other subsidiaries registered with
the Commodity Futures Trading Commission (the
“CFTC”) as commodity pool operators and commodity
trading advisors. These CFTC-registered
subsidiaries are also members of the National
Futures Association. The Firm’s U.S. energy
business is subject to regulation by the Federal
Energy Regulatory Commission. It is also subject to
other extensive and evolving energy, commodities,
environmental and other governmental regulation
both in the U.S. and other jurisdictions globally.
The types of activities in which the non-U.S.
branches of JPMorgan Chase Bank, N.A., and the
international subsidiaries of JPMorgan Chase may
engage are subject to various restrictions imposed
by the Federal Reserve Board. Those non-U.S.
branches and international subsidiaries also are
subject to the laws and regulatory authorities of
the countries in which they operate.
The activities of JPMorgan Chase Bank, N.A. and
Chase Bank USA, N.A. as consumer lenders also are
subject to regulation under various U.S. federal
laws, including the Truth-in-Lending, Equal Credit
Opportunity, Fair Credit Reporting, Fair Debt
Collection Practice and Electronic Funds Transfer
acts, as well as various state laws. These
statutes impose requirements on consumer loan
origination and collection practices.
Under the requirements imposed by GLBA, JPMorgan
Chase and its subsidiaries are required
periodically to disclose to their retail customers
the Firm’s policies and practices with respect to
the sharing of nonpublic customer information with
JPMorgan Chase affiliates and others, and the
confidentiality and security of that information.
Under GLBA, retail customers also must be given
the opportunity to “opt out” of
information-sharing arrangements with
nonaffiliates, subject to certain exceptions set
forth in GLBA.
ITEM 1A: RISK FACTORS
The following discussion sets forth some of the more important risk factors that could materially
affect our financial condition and operations. Other factors that could affect our financial
condition and operations are discussed in the “Forward-looking statements” section on page 115.
However, factors besides those discussed below, in MD&A or
elsewhere in this or other reports that we filed or furnished with the SEC, also could adversely
affect us. You should not consider any descriptions of such factors to be a complete set of all
potential risks that could affect us.
Our
results of operations have been, and may continue to be, adversely affected by U.S. and
international financial market and economic conditions.
Our businesses have been, and in the future will continue to be, materially affected by economic
and market conditions, including factors such as the liquidity of the global financial markets; the
level and volatility of debt and equity prices, interest rates and currency and commodities prices;
investor sentiment; corporate or other scandals that reduce confidence in the financial markets;
inflation; the availability and cost of capital and credit; the occurrence of natural disasters,
acts of war or terrorism; and the degree to which U.S. or international economies are expanding or
experiencing recessionary pressures. These factors can affect, among other things, the activity
level of clients with respect to the size, number and timing of transactions involving our
investment and commercial banking businesses, including our underwriting and advisory businesses;
the realization of cash returns from our private equity and principal investments businesses; the
volume of transactions that we execute for our customers and, therefore, the revenue we receive
from commissions and spreads; the number or size of underwritings we manage on behalf of clients;
and the willingness of financial sponsors or other investors to participate in loan syndications or
underwritings managed by us.
We generally maintain large trading portfolios in the fixed income, currency, commodity and equity
markets and we may have from time to time significant investment positions, including positions in
securities in markets that lack pricing transparency or liquidity. The revenue derived from
mark-to-market values of our businesses are affected by many factors, including our credit
standing; our success in proprietary positioning; volatility in interest rates and equity, debt and
commodities markets; credit spreads and availability of liquidity in the capital markets; and other
economic and business factors. We anticipate that revenue relating to our trading and principal
investment businesses will continue to experience volatility and there can be no assurance that
such volatility relating to the above factors or other conditions that may affect pricing or our
ability to realize returns from such investments could not materially adversely affect our
earnings.
The fees we earn for managing third-party assets are also dependent upon general economic
conditions. For example, a higher level of U.S. or non-U.S. interest rates or a downturn in trading
markets could affect the valuations of the third-party assets we manage or hold in custody, which,
in turn, could affect our revenue. Moreover, even in the absence of a market downturn, below-market
or sub-par performance by our investment management businesses could result in outflows of assets
under management and supervision and, therefore, reduce the fees that we receive.
Our consumer businesses are particularly affected by domestic economic conditions. Such conditions
include U.S. interest rates; the rate of unemployment; housing prices; the level of consumer
confidence; changes in consumer spending; and the number of personal bankruptcies, among others.
The deterioration of these conditions can diminish demand for the consumer businesses’ products and
services, or increase the cost to provide such products and services. In addition, adverse economic
conditions, such as declines in home prices, could lead to an increase in mortgage and other loan
delinquencies and higher net charge-offs, which can adversely affect our earnings.
During 2008, U.S. and global financial markets were extremely volatile and were materially and
adversely affected by a significant lack of liquidity, loss of confidence in the financial
sector,
disruptions in the credit markets, reduced business activity, rising unemployment, declining home
prices, and erosion of consumer confidence. These factors contributed to adversely affecting our
business, financial condition and results of operations in 2008 and there is no assurance when such
conditions will ameliorate.
If we do not effectively manage our liquidity, our business could be negatively affected.
Our liquidity is critical to our ability to operate our businesses, grow and be profitable. Some
potential conditions that could negatively affect our liquidity include illiquid or volatile
markets, diminished access to capital markets, unforeseen cash or capital requirements (including,
among others, commitments that may be triggered to special purpose entities (“SPEs”) or other
entities), difficulty or inability to sell assets, unforeseen
outflows of cash or collateral, and lack of market or customer
confidence in us or our prospects.
These conditions may be caused by events over which we have little or no control. The liquidity
crisis experienced in 2008 increased our cost of funding and limited our access to some of our
traditional sources of liquidity such as securitized debt offerings backed by mortgages, loans,
credit card receivables and other assets. If current market conditions continue, our liquidity
could be adversely affected.
The credit ratings of JPMorgan Chase & Co., JPMorgan Chase Bank, N.A. and Chase Bank USA, N.A. are
important in order to maintain our liquidity. A reduction in their credit ratings could have an
adverse effect on our access to
liquidity sources, increase our cost of funds, trigger additional collateral or funding
requirements, and decrease the number of investors and counterparties willing to lend to us,
thereby curtailing our business operations and reducing our profitability. Reduction in the ratings
of certain SPEs or other entities to which we have a funding or other commitment could also
negatively affect our liquidity where such ratings changes lead, directly or indirectly, to us
being required to purchase assets or otherwise provide funding. Critical factors in maintaining
high credit ratings include a stable and diverse earnings stream, strong capital ratios, strong
credit quality and risk management controls, diverse funding sources, and disciplined liquidity
monitoring procedures.
Our cost of obtaining long-term unsecured funding is directly related to our credit spreads (the
amount in excess of the interest rate of U.S. Treasury securities (or other benchmark securities)
of the same maturity that we need to pay to our debt investors). Increases in our credit spreads
can significantly increase the cost of this funding. Changes in credit spreads are continuous and
market-driven, and influenced by market perceptions of our creditworthiness. As such, our credit
spreads may be unpredictable and highly volatile.
As a holding company, we rely on the earnings of our subsidiaries for our cash flow and consequent
ability to pay dividends and satisfy our obligations. These payments by subsidiaries may take the
form of dividends, loans or other payments. Several of our principal subsidiaries are subject to
capital adequacy requirements or other regulatory or contractual restrictions on their ability to
provide such payments. Limitations in the payments we receive from our subsidiaries could
negatively affect our liquidity position.
The soundness of our customers, clients and counterparties, including other financial institutions,
could adversely affect us.
A number of our products expose us to credit risk, including loans, leases and lending commitments,
derivatives, trading account assets and assets held-for-sale. As one of the nation’s largest
lenders, we have exposures to many different
products
and counterparties, and the credit quality of
our exposures can have a significant impact on our earnings. We estimate and establish reserves for
credit risks and potential credit losses inherent in our credit exposure (including unfunded
lending commitments). This process, which is critical to our financial results and condition,
requires difficult, subjective and complex judgments, including forecasts of how these economic
conditions might impair the ability of our borrowers to repay their loans. As is the case with any
such assessments, there is always the chance that we will fail to identify the proper factors or
that we will fail to accurately estimate the impact of factors that we identify. Any such failure
could result in increases in delinquencies and default rates.
Financial services institutions are interrelated as a result of trading, clearing, counterparty, or
other relationships. We routinely execute transactions with counterparties in the financial
services industry, including brokers and dealers, commercial banks, investment banks, mutual and
hedge funds, and other institutional clients. Many of these transactions expose us to credit risk
in the event of default by the counterparty or client, which can be exacerbated during periods of
market illiquidity, such as experienced in 2008. During such periods, our credit risk also may be
further increased when the collateral held by us cannot be realized upon or is liquidated at prices
that are not sufficient to recover the full amount of the loan or derivative exposure due to us. In
addition, disputes with counterparties as to the valuation of collateral significantly increases in
times of market stress and illiquidity. There is no assurance that any such losses would not
materially and adversely affect our results of operations or earnings.
As an example of the risks associated with our relationships with other financial institutions is
the collapse of Lehman Brothers Holdings Inc. (“LBHI”). On September 15, 2008, LBHI filed a
voluntary petition for relief under Chapter 11 of Title 11 of the United States Code (the
“Bankruptcy Code”) in the United States Bankruptcy Court for the Southern District of New York, and
thereafter several of its subsidiaries also filed voluntary petitions for relief under Chapter 11
of the Bankruptcy Code in the court (LBHI and such subsidiaries collectively, “Lehman”). On
September 19, 2008, a liquidation case under the Securities Investor Protection Act was commenced
in the United States District Court for the Southern District of New York for Lehman Brothers Inc.
(“LBI”), LBHI’s U.S. broker-dealer subsidiary, and the court now presides over the LBI SIPA
liquidation case. We were LBI’s clearing bank and are the largest secured creditor in the Lehman
and LBI cases, according to Lehman’s schedules. We anticipate that claims may be asserted against us
and/or our security interests, including by the LBHI Creditors Committee, the SIPA Trustee
appointed in the LBI liquidation case, the principal acquiror of LBI’s assets, and others in
connection with Lehman and LBI cases. We intend to defend ourself against any such claims.
As a result of the current economic environment there is a greater likelihood that more of our
customers or counterparties could become delinquent on their loans or other obligations to us
which, in turn, could result in a higher level of charge-offs and provision for credit losses, or
requirements that we purchase assets or provide other funding, any of which could adversely affect
our financial condition. Moreover, a significant deterioration in the credit quality of one of our
counterparties could lead to concerns about the credit quality of other counterparties in the same
industry, thereby exacerbating our credit risk exposure, and increasing the losses, including
mark-to-market losses, we could incur in our trading, clearing, and proprietary businesses.
Concentration of credit and market risk could increase the potential for significant losses.
We have exposure to increased levels of risk when a number of customers are engaged in similar
business activities or activities in the same geographic region, or when they have similar economic
features that would cause their ability to meet contractual obligations to be similarly affected by
changes in economic conditions. We regularly monitor various segments of our portfolio exposures to
assess potential concentration risks. Our efforts to diversify or hedge our credit portfolio
against concentration risks may not be successful and any concentration of credit risk could
increase the potential for significant losses in our credit portfolio. In addition, disruptions in
the liquidity or transparency of the financial markets may result in our inability to sell,
syndicate or realize upon securities, loans or other instruments or positions held by us,
thereby leading to increased concentrations
of such positions. These concentrations could expose us to
losses if the mark-to-market value of the securities, loans or other instruments or positions
decline causing us to take write downs. Moreover, the inability to reduce our positions not only
increases the market and credit risks associated with such positions, but also increases the level
of risk-weighted assets on our balance sheet, thereby increasing our capital requirements and
funding costs, all of which could adversely affect our
businesses’ operations and profitability.
Our framework for managing risks may not be effective in mitigating risk and loss to us.
Our risk management framework seeks to mitigate risk and loss to us. We have established processes
and procedures intended to identify, measure, monitor, report and analyze the types of risk to
which we are subject, including liquidity risk, credit risk, market risk, interest rate risk,
operational risk, legal and fiduciary risk, reputational risk and private equity risk, among
others. However, as with any risk management framework, there are inherent limitations to our risk
management strategies as there may exist, or develop in the future, risks that we have not
appropriately anticipated or identified. If our risk management framework proves ineffective, we
could suffer unexpected losses and could be materially adversely affected.
Our risk management strategies may not be effective because in a difficult or less liquid market
environment other market participants may be attempting to use the same or similar strategies to
deal with the difficult market conditions. In such circumstances, it may be difficult for us to
reduce our risk positions due to the activity of such other market participants.
Our derivatives businesses may expose us to unexpected market, credit and operational risks that
could cause us to suffer unexpected losses. Severe declines in asset values, unanticipated credit
events, or unforeseen circumstances that may cause previously uncorrelated factors to become
correlated may create losses resulting from risks not appropriately taken into account in the
development, structuring or pricing of a derivative instrument. In addition, certain of our
derivative transactions require the physical settlement by delivery of securities, commodities or
obligations that we do now own; if we are not able to obtain such securities, commodities or
obligations within the required timeframe for delivery, this could cause us to forfeit payments
otherwise due to us and could result in settlement delays, which could damage our reputation and
ability to transact future business. In addition, many derivative transactions are not cleared and
settled through a central clearinghouse or exchange, and they may not always be confirmed or
settled by counterparties on a timely basis. In these situations, we are subject to heightened
credit and operational risk, and in the event of a default, we may find the contract more difficult
to enforce. Further, as new and more complex derivative products are created, disputes regarding
the terms or the settlement procedures of the contracts could arise, which could force us to incur
unexpected costs, including transaction and legal costs, and impair our ability to manage
effectively our risk exposure from these products.
Many of our hedging strategies and other risk management techniques have a basis in historic market
behavior, and all
such strategies and techniques are based to some degree on management’s
subjective judgment. For example, many models used by us are based on assumptions regarding
correlations among prices of various asset classes or other market indicators. In times of market
stress, such as occurred during 2008, or in the event of other unforeseen circumstances, previously
uncorrelated indicators may become correlated, or conversely, previously correlated indicators may
make unrelated movements. These sudden market movements or unanticipated or unidentified market or
economic movements have in some circumstances limited the effectiveness of our risk management
strategies, causing us to incur losses. In addition, as our businesses grow and the markets in
which they operate continue to evolve, our risk management framework may not always keep sufficient
pace with those changes. For example, there is the risk that the credit and market risks associated
with new products or new business strategies may not be appropriately identified, monitored or
managed. There can be no assurance that our risk management framework, including our underlying
assumptions or strategies, will at all times be accurate and effective.
Our operations are subject to risk of loss from unfavorable economic, monetary, political, legal
and other developments in the United States and around the world.
Our businesses and earnings are affected by the fiscal and other policies that are adopted by
various regulatory authorities of the United States, non-U.S. governments and international
agencies.
The Board of Governors of the Federal Reserve System regulates the supply of money and credit in
the United States. Its policies determine in large part the cost of funds for lending and investing
and the return earned on those loans and investments. The market impact from such policies can also
materially decrease the value of financial assets that we hold, such as debt securities and
mortgage servicing rights (“MSRs”). Its policies also can adversely affect borrowers, potentially
increasing the risk that they may fail to repay their loans or satisfy their obligations to us.
Changes in Federal Reserve policies are beyond our control and, consequently, the impact of these
changes on our activities and results of operations is difficult to predict.
Our businesses and revenue are also subject to the risks inherent in maintaining international
operations and in investing and trading in securities of companies worldwide. These risks include,
among others, risk of loss from the outbreak of hostilities or acts of terrorism and various
unfavorable political, economic, legal or other developments, including social or political
instability, changes in governmental policies or policies of central banks, expropriation,
nationalization, confiscation of assets, price controls, capital controls, exchange controls, and
changes in laws and regulations. Further, various countries in which we operate or invest, or in
which we may do so in the future, have in the past experienced severe economic disruptions,
including extreme currency fluctuations, high inflation, or low or negative growth, among other
negative conditions. Crime, corruption, war or military actions, acts of terrorism and a
lack of an established legal and regulatory framework are additional challenges in some of these
countries, particularly in the emerging markets. Revenue from international operations and trading
in non-U.S. securities may be subject to negative fluctuations as a result
of the above
considerations. The impact of these fluctuations could be accentuated as some trading markets are
smaller, less liquid and more volatile than larger markets. Also, any of the above-mentioned events
or circumstances in one country can and has in the past, affected our operations and investments
in another country or countries. Any such unfavorable conditions or developments could have an
adverse impact on our business and results of operations.
The emergence of a widespread health emergency or pandemic also could create economic or financial
disruption that could negatively affect our revenue and operations or impair our ability to manage
our businesses in certain parts of the world.
Our power generation and commodities activities are subject to extensive regulation, potential
catastrophic events and environmental risks and regulation that may expose it to significant cost
and liability.
We engage in power generation, and in connection with the commodities activities of our Investment
Bank, we engage in the storage, transportation, marketing or trading of several commodities,
including metals, agricultural products, crude oil, oil products, natural gas, electric power,
emission credits, coal, freight, and related products and indices. As a result of these activities,
we are subject to extensive and evolving energy, commodities, environmental, and other governmental
laws and regulations. We expect laws and regulations affecting our power generation and commodities
activities to expand in scope and complexity. We may incur substantial costs in complying with
current or future laws and regulations and the failure to comply with these laws and regulations
may result in substantial civil and criminal fines and penalties. In addition, liability may be
incurred without regard to fault under certain environmental laws and regulations for remediation
of contaminations. Our power generation and commodities activities also further exposes us to the
risk of unforeseen and catastrophic events, including natural disasters, leaks, spills, explosions,
release of toxic substances, fires, accidents on land and at sea, wars, and terrorist attacks that
could result in personal injuries, loss of life, property damage, damage to our reputation and
suspension of operations. In addition, our power generation activities are subject to disruptions,
many of which are outside of our control, from the breakdown or failure of power generation
equipment, transmission lines or other equipment or processes, and the contractual failure of
performance by third-party suppliers or service providers, including the failure to obtain and
deliver raw materials necessary for the operation of power generation facilities. We attempt to
mitigate our risks, but our actions may not prove adequate to address every contingency. In
addition, insurance covering some of these risks may not be available, and the proceeds, if any,
from insurance recovery may not be adequate to cover liabilities with respect to particular
incidents. As a result, our financial condition and results of operations may be adversely affected
by such events.
We rely on our systems, employees and certain counterparties, and certain failures could materially
adversely affect our operations.
Our businesses are dependent on our ability to process, record and monitor a large number of
increasingly complex transactions. If any of our financial, accounting, or other data
processing
systems fail or have other significant shortcomings, we could be materially adversely affected. We
are similarly dependent on our employees. We could be materially adversely affected if one of our
employees causes a significant operational break-down or failure, either as a result of human error
or where an individual purposefully sabotages or fraudulently manipulates our operations or
systems. Third parties with which we do business could also be sources of operational risk to us,
including relating to breakdowns or failures of such parties’ own systems or employees. Any of
these occurrences could diminish our ability to operate one or more of our businesses, or result in
potential liability to clients, reputational damage and regulatory intervention, any of which could
materially adversely affect us.
If personal, confidential or proprietary information of customers or clients in our possession were
to be mishandled or misused, we could suffer significant regulatory consequences, reputational
damage and financial loss. Such mishandling or misuse could include, for example, if such
information were erroneously provided to parties who are not permitted to have the information,
either by fault of our systems, employees, or counterparties, or where such information is
intercepted or otherwise inappropriately taken by third parties.
We may be subject to disruptions of our operating systems arising from events that are wholly or
partially beyond our control, which may include, for example, computer viruses or electrical or
telecommunications outages, natural disasters, disease pandemics or other damage to property or
physical assets, or events arising from local or larger scale politics, including terrorist acts.
Such disruptions may give rise to losses in service to customers and loss or liability to us.
In a firm as large and complex as us, lapses or deficiencies in internal control over financial
reporting may occur from time to time, and there is no assurance that significant deficiencies or
material weaknesses in internal controls may not occur in the future. In addition, there is the
risk that our controls and procedures as well as business continuity and data security systems
prove to be inadequate. Any such failure could affect our operations and could materially adversely
affect our results of operations by requiring us to expend significant resources to correct the
defect, as well as by exposing us to litigation, regulatory fines or penalties or losses not
covered by insurance.
We operate within a highly regulated industry and our business and results are
significantly affected by the laws and regulations to which we are subject.
We operate within a highly regulated industry. We are subject to regulation under state and federal
laws in the U.S., as well as the applicable laws of each of the various other jurisdictions outside
the U.S. in which we do business. These laws and regulations affect the type and manner in which we
do business and may limit our ability to expand our product offerings, pursue acquisitions, or
restrict the scope of operations and services provided.
Recent market and economic conditions have led to new legislation and numerous proposals for
changes in the regulation of the financial services industry, including significant additional
legislation and regulation in the United States. In response to such market and economic
conditions, the United States government, particularly the U.S. Department of the Treasury, the
Board of Governors of the Federal Reserve System, the FDIC, and foreign governments,
have taken a
variety of extraordinary measures designed to restore confidence in the financial markets, increase
liquidity and to strengthen financial institutions. For example, on October 3, 2008 and on February17, 2009, the EESA and the ARRA, respectively, were signed into law. These laws are
intended to provide fiscal stimulus and stability to the U.S. economy, by among other things,
permitting the U.S. Treasury to make direct investments in financial institutions pursuant to the
Capital Purchase Program. There can be no assurance, however, as to the actual impact that these
laws and their implementing regulations, or any other governmental program, will have on the
financial markets. The failure of the financial markets to stabilize and a continuation or
worsening of current financial market and economic conditions could continue to materially and
adversely affect our business, financial condition, results of operations, access to credit or the
trading price of our common stock.
Participation in current or future government programs adopted in response to recent market events
and economic conditions may subject us to restrictions and additional oversight on the manner in
which we operate our business. We are currently participating in the Capital Purchase Program, and
under the terms of the program, as amended by the ARRA, the consent of the U.S. Treasury is
required for us to, among other things, increase our common stock
dividend from the amount of the last quarterly stock dividend
declared by us prior to October 14, 2008 or, except in limited
circumstances, repurchase our common stock or other preferred stock unless the Series K Preferred
Stock that was issued to the U.S. Treasury under the Capital Purchase Program has been redeemed or
the U.S. Treasury has transferred all of the Series K Preferred Stock to a third party. The ARRA
also imposes restrictions on our ability to pay incentive compensation to certain of our employees.
There can be no assurance that any additional restrictions imposed by reason of our participation
in the Capital Purchase Program or other government programs will not
have an adverse effect on our
business, results of operations and financial condition.
New
legislation and regulatory changes could cause business disruptions, result in significant loss of
revenue, limit our ability to pursue business opportunities we might otherwise consider engaging
in, impact the value of assets that we hold, require us to change certain of our business
practices, impose additional costs on us or otherwise adversely
affect our business. For example, on December 18, 2008, the Board of Governors of the Federal Reserve System adopted
enhanced regulations for credit cards through amendments to Regulation Z, which implements the
Truth-in-Lending Act, and also new regulations governing unfair or deceptive acts or practices
under the Federal Trade Commission Act. These regulatory changes will require us to invest
significant management attention and resources to make the necessary disclosure and system changes,
and could adversely affect our business.
Additional legislation and regulations may by enacted or promulgated in the future, and we are
unable to predict the form such legislation or regulation may take, or the degree to which we would
need to modify our businesses or operations to comply with such legislation or regulation. For
example, proposed legislation has been introduced in Congress that would amend to the Bankruptcy
Code to permit modifications of certain mortgages that are secured by a Chapter 13 debtor’s
principal residence. Proposed legislation has also been introduced in Congress that would, among
other things, prescribe when interest can be charged on revolving credit card accounts, prescribe
when and how interest rates can be increased, limit events of default that can result in interest
rate increases on existing balances, restrict the imposition of certain fees, require a specified
cutoff hour when payments must be credited to accounts, prescribe how payments must be allocated to
outstanding balances on accounts and restrict the issuance of credit cards for persons under 21
years of age except in certain circumstances. There can be no assurance that if any such
legislation were enacted that it would not have an adverse effect on our business, results of
operations or financial condition.
If we do
not comply with the legislation and regulations that apply to our
operations, we may be subject to fines, penalties or
material restrictions on our businesses in the jurisdiction where the violation occurred. In recent
years, regulatory oversight and enforcement have increased substantially, imposing additional costs
and increasing the potential risks associated with our operations. If this regulatory trend
continues, it could adversely affect our operations and, in turn, our financial results. In
addition, adverse publicity and damage to our reputation arising from the failure or perceived
failure to comply with legal, regulatory or contractual requirements could affect our ability to
attract and retain customers or to maintain access to capital markets, which could adversely affect
our financial condition.
We face significant legal risks, both from regulatory investigations and proceedings and from
private actions brought against us.
We are named as a defendant or are otherwise involved in various legal proceedings, including class
actions and other litigation or disputes with third parties, as well as investigations or
proceedings brought by regulatory agencies. Actions brought against us may result in judgments,
settlements, fines, penalties or other results adverse to us, which could materially adversely
affect our business, financial condition or results of operation, or cause us serious reputational
harm. As a participant in the financial services industry, it is likely we will continue to
experience a high level of litigation and regulatory scrutiny and investigations related to our
businesses and operations.
There is increasing competition in the financial services industry which may adversely affect our
results of operations.
We operate in a highly competitive environment and we expect competitive conditions to continue to
intensify as continued merger activity in the financial services industry produces larger,
better-capitalized and more geographically diverse companies that are capable of offering a wider
array of financial products and services at more competitive prices. Consolidations in the
financial services industry increased substantially during 2008, as several major U.S.
financial institutions merged, were forced to sell assets and, in some cases failed.
We also face an increasing array of competitors. Competitors include other banks, brokerage firms,
investment banking companies, merchant banks, hedge funds, insurance companies, mutual fund
companies, credit card companies, mortgage banking companies, trust companies, securities
processing companies, automobile financing companies, leasing companies, e-commerce and other
Internet-based companies, and a variety of other financial services and advisory companies.
Technological advances and the growth of e-commerce have made it possible for non-depository
institutions to offer products and services that traditionally were banking products, and for
financial institutions and other companies to provide electronic and Internet-based financial
solutions, including electronic securities trading. Our businesses generally compete on the basis
of the quality and variety of our products and services, transaction execution, innovation,
reputation and price. Ongoing or increased competition in any one or all of these areas may put
downward pressure on prices for our products and services or may cause us to lose market share.
Increased competition also may require us to make additional capital investment in our businesses
in order to remain competitive. These investments may increase expense or may require us to extend
more of our capital on behalf of clients in order to execute larger, more competitive transactions.
There can be no assurance that the significant and increasing competition in the financial services
industry will not materially adversely affect our future results of operations.
Our acquisitions and the integration of acquired businesses may not result in all of the benefits
anticipated.
We have in the past and may in the future seek to grow our business by acquiring other businesses.
There can be no assurance that our acquisitions will have the anticipated positive results,
including results relating to: the total cost of integration; the time required to complete the
integration; the amount of longer-term cost savings; the overall performance of the combined
entity; or an improved price for our common stock. Integration of an acquired business can be
complex and costly, sometimes including combining relevant accounting and data processing systems
and management controls, as well as managing relevant relationships with employees, clients,
suppliers and other business partners. Integration efforts could divert management attention and
resources, which could adversely affect our operations or results.
Given the continued market volatility and uncertainty, we may continue to experience increased
credit costs or need to take additional markdowns and allowances for loan losses on the assets and
loans acquired in the merger (the “Bear Stearns merger”)
by and among JPMorgan Chase and The Bear Stearns Companies Inc. (“Bear Stearns”) and in connection with the acquisition of Washington Mutual Bank’s (“Washington Mutual”) banking operations (the “Washington Mutual transaction”) that could
negatively affect our financial condition and results of operations in the future. There is no
assurance that as our integration efforts continue in connection with these transactions, other
unanticipated costs or losses will not be incurred.
Acquisitions may also result in business disruptions that cause us to lose customers or cause
customers to remove their accounts from us and move their business to competing financial
institutions. It is possible that the integration process related to acquisitions could result in
the disruption of our ongoing businesses or inconsistencies in standards, controls, procedures and
policies that could adversely affect our ability to maintain relationships with clients, customers,
depositors and employees. The loss of key employees in connection with an acquisition could
adversely affect our ability to successfully conduct our business.
Damage to our reputation could damage our businesses.
Maintaining a positive reputation is critical to our attracting and maintaining customers,
investors and employees. Damage to our reputation can therefore cause significant harm to our
business and prospects. Harm to our reputation can arise from numerous sources, including, among
others, employee misconduct, litigation or regulatory outcomes, failing to deliver minimum
standards of service and quality, compliance failures, unethical behavior, and the activities of
customers and counterparties. Further, negative publicity regarding us, whether or not true, may
also result in harm to our prospects.
We could suffer significant reputational harm if we fail to properly identify and manage potential
conflicts of interest. Management of potential conflicts of interests has become increasingly
complex as we expand our business activities through more numerous transactions, obligations and
interests with and among our clients. The failure to adequately address, or the perceived failure
to adequately address, conflicts of interest could affect the willingness of clients to deal with
us, or give rise to litigation or enforcement actions. Therefore, there can be no assurance that
conflicts of interest will not arise in the future that could cause material harm to us.
Our ability to attract and retain qualified employees is critical to the success of our business
and failure to do so may materially adversely affect our performance.
Our employees are our most important resource and, in many areas of the financial services
industry, competition for qualified personnel is intense. The executive compensation restrictions
currently, or that may in the future may be, imposed on us as a result of our participation in the
Capital Purchase Program or other government programs, may adversely affect our ability to attract
and retain qualified senior management and employees. If we are unable to continue to retain and
attract qualified employees, our performance, including our competitive position, could be
materially adversely affected.
Our financial statements are based in part on assumptions and estimates which, if wrong, could
cause unexpected losses in the future.
Pursuant to accounting principles generally accepted in the United States of America,
we are required to use certain assumptions and estimates in preparing our financial statements,
including in determining credit loss reserves, reserves related to litigations and the fair value
of certain assets and liabilities, among other items. If assumptions or estimates underlying our
financial statements are incorrect, we may experience material losses.
For example, we make judgments in connection with our consolidation analysis of SPEs. If it is
later determined that non-consolidated SPEs should be consolidated, this could negatively affect
our Consolidated Balance Sheets, related funding requirements, capital ratios and, if the SPEs’
assets include unrealized losses, could require us to recognize those losses.
Certain of our financial instruments, including trading assets and liabilities, available-for-sale securities, certain loans, MSRs, private equity investments, structured notes and certain
repurchase and resale agreements, among other items, require a determination of their fair value in
order to prepare our financial statements. Where quoted market prices are not available, we may
make fair value determinations based on internally developed models or other means which ultimately
rely to some degree on management judgment. Some of these and other assets and liabilities may have
no direct observable price levels, making their valuation particularly subjective, being based on
significant estimation and judgment. In addition, sudden illiquidity in markets or declines in
prices of certain loans and securities may make it more difficult to value certain balance sheet
items, which may lead to the possibility that such valuations will be subject to further change or
adjustment and could lead to declines in our earnings.
ITEM 1B: UNRESOLVED SEC STAFF COMMENTS
None.
ITEM 2: PROPERTIES
JPMorgan
Chase’s headquarters is located
in New York City at 270 Park Avenue, which is a
50-story office building owned by JPMorgan Chase.
This location contains approximately 1.3 million
square feet of space. The building is currently
undergoing a major renovation in five stages. The
design seeks to attain the highest sustainability
rating for renovations of existing buildings under
the Leadership in Energy and Environmental Design
(“LEED”) Green Building Rating System. The
renovation of the top 15 floors is complete. By
year-end 2009, the next 19 floors are expected to
be complete and the mechanical infrastructure
refresh will be substantially complete with the
other stages to follow in the multi-year program.
In connection with the Bear Stearns merger,
JPMorgan Chase acquired 383 Madison Avenue in New
York City, a 45-story, 1.1 million square-foot
office building on land which is subject to a
ground lease for an additional 88 years. This
building serves as the U.S. headquarters of
JPMorgan Chase’s Investment Bank.
In total, JPMorgan Chase owned or leased
approximately 13.0 million square feet of
commercial office space and retail space in New
York City at December 31, 2008. JPMorgan Chase and its
subsidiaries also own or lease significant
administrative and operational facilities in
Houston and Dallas, Texas (4.8 million square
feet); Chicago, Illinois (4.0 million square
feet); Columbus, Ohio (2.7 million square
feet); Seattle, Washington (1.6 million square
feet); Phoenix, Arizona (1.4 million square
feet); Jersey City, New Jersey (1.2 million square
feet); San Francisco, California (1.1 million square
feet); Wilmington, Delaware (1.0 million square
feet); Tampa, Florida (1.0 million square feet); San
Antonio, Texas (1.0 million square feet); and 5,474
retail branches in 23 states. At December 31, 2008, the Firm occupied
approximately 75.9 million total square feet of
space in the United States.
At
December 31, 2008, the Firm managed and occupied approximately 3.8
million total square feet of space in the United
Kingdom, Europe, Middle East and Africa. In the
United Kingdom, JPMorgan Chase leased
approximately 2.6 million square feet of office
space and owned a 360,000 square-foot operations
center at December 31, 2008.
In 2008, JPMorgan Chase acquired a 999-year
leasehold interest in land at Canary Wharf,
London. It is intended to be the future site for
construction of a new European headquarters
building, which can contain up
to approximately 1.9 million square feet of space
and have up to five trading floors of
approximately 80,000 square feet each. JPMorgan
Chase, by agreement with the developer, has the
ability to defer commencement of the main
construction through at least October 2010. The
building design will strive to achieve the highest
possible environmental efficiency rating.
In addition, JPMorgan Chase and its subsidiaries
occupy offices and other administrative and
operational facilities in the Asia Pacific region,
Latin America and Canada under various types of
ownership and leasehold agreements, aggregating
approximately 3.2 million total square feet of
space at December 31, 2008. The properties occupied by JPMorgan Chase
are used across all of the Firm’s business segments
and for corporate purposes.
JPMorgan Chase continues to evaluate its current
and projected space requirements and may determine
from time to time that certain of its premises and
facilities are no longer necessary for its
operations. There is no assurance that the Firm
will be able to dispose of any such excess premises
or that it will not incur charges in connection
with such dispositions. Such disposition costs may
be material to the Firm’s results of operations in
a given period. For a discussion of occupancy
expense, see the Consolidated Results of Operations
discussion on pages 33–37.
ITEM 3: LEGAL PROCEEDINGS
Bear Stearns Shareholder Litigation and Related
Matters. Various shareholders of Bear Stearns have
commenced purported class actions against Bear
Stearns and certain of its former officers and/or
directors on behalf of all persons who purchased or
otherwise acquired common stock of Bear Stearns
between December 14, 2006 and March 14, 2008 (the
“Class Period”). The actions, originally commenced
in several United States District Courts, allege
that the defendants issued materially false and
misleading statements regarding Bear Stearns’
business and financial results and that, as a
result of those false statements, Bear Stearns’
common stock traded at artificially inflated prices
during the Class Period. In connection with these
allegations, the complaints assert claims for
violations of Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934. Separately,
several individual shareholders of Bear Stearns
have commenced or threatened to commence arbitration proceedings and lawsuits
asserting claims similar to those in the putative
class actions.
In addition, Bear Stearns and certain of its former
officers and/or directors have also been named as
defendants in a number of putative class actions
commenced in the United States District Court for
the Southern District of New York purporting to
represent the interests of participants in the Bear
Stearns Employee Stock Ownership Plan (“ESOP”)
during the time period of December 2006 through the
date of
the complaints. These
actions allege defendants breached their fiduciary
duties
to plaintiffs and to the other participants and
beneficiaries of the ESOP by (a) failing to
prudently manage the ESOP’s investment in Bear
Stearns securities; (b) failing to communicate fully
and accurately about the risks of the ESOP’s
investment in Bear Stearns stock; (c) failing to
avoid or address alleged conflicts of interest; and
(d) failing to monitor those who managed and
administered the ESOP. In connection with these
allegations, each plaintiff asserts claims for
violations under various sections of the Employee
Retirement Income Security Act (“ERISA”) and seeks
reimbursement to the ESOP for all losses, an
unspecified amount of monetary damages and
imposition of a consecutive trust.
Furthermore, former members of Bear Stearns’ Board
of Directors and certain of Bear Stearns’ former
executive officers have been named as defendants in
two purported shareholder derivative suits, each of
which was commenced in the United States District
Court for the Southern District of New York. Bear
Stearns was named as a nominal defendant in both
actions. By court order dated February 14, 2008,
the actions were consolidated. A consolidated
amended complaint was filed on March 3, 2008,
asserting claims for breach of fiduciary duty,
violations of federal securities laws, waste of
corporate assets and gross mismanagement, unjust
enrichment, abuse of control and indemnification
and contribution in connection with the losses
sustained by Bear Stearns as a result of its
purchases of sub-prime loans and certain
repurchases of its own common stock. Certain
individual defendants are also alleged to have sold
their holdings of Bear Stearns common stock
while in possession of material nonpublic
information. The amended complaint seeks
compensatory damages in an unspecified amount and
an order directing Bear Stearns to improve its
corporate governance procedures.
On August 18, 2008, the Judicial Panel on
Multidistrict Litigation (“MDL Panel”) issued a
Transfer Order joining for pre-trial purposes
before the United States District Court for the
Southern District of New York all then-pending
securities and ERISA actions, as well as any
later-filed actions, making allegations concerning
“whether Bear Stearns and certain of its current
and former officers and directors knowingly made
material misstatements or omissions concerning the
company’s financial health that misled investors
and caused investor losses when the company’s stock
price fell in March 2008.” The consolidated
shareholders’ derivative lawsuit was also the
subject of the Transfer order. All such actions
were assigned to District Judge Robert Sweet. By
order dated January 5, 2009, District Judge Sweet
ordered the various putative securities class
actions to be consolidated, and ordered that the
putative ERISA class actions be separately
consolidated. The Court also appointed lead
plaintiffs and lead plaintiffs’ counsel in both
consolidated actions and appointed lead plaintiffs’
counsel in the consolidated shareholder derivative
action.
Bear Stearns Merger Litigation. Seven putative
class actions (five that were commenced in New York
and two that were commenced in Delaware) were
consolidated in
New York State Court in Manhattan under the caption
In re Bear Stearns Litigation. Bear Stearns, as
well as its former directors and certain of its former
executive officers, were named as defendants.
JPMorgan Chase was also named as a defendant. The
actions, which were filed in the Supreme Court of
the New York State
Court, allege, among other things, that the
individual defendants breached their fiduciary
duties and obligations to Bear Stearns’
shareholders by agreeing to the proposed merger.
The Firm was alleged to have aided and abetted the
alleged breaches of fiduciary duty; breached its
fiduciary duty as controlling
shareholder/controlling entity; tortuously
interfered with the Bear Stearns shareholders’
voting rights; and was also alleged to have been
unjustly enriched. Plaintiffs initially sought to
enjoin the proposed merger and enjoin the Firm from
voting certain shares acquired by the Firm in
connection with the proposed merger. The plaintiffs
subsequently informed the Court that they were
withdrawing that motion but amended the
consolidated complaint to pursue claims, which
included a claim for an unspecified amount of
compensatory damages. In December 2008, the court ruled in favor of
us and other defendants on our and their motion for summary judgment.
As a result, the case has been dismissed pending the plaintiff’s
appeal from the summary judgment ruling.
Municipal Derivatives Investigation and Antitrust
Litigation. The New York field office of the
Department of Justice’s Antitrust Division and the
Philadelphia Office of the SEC have been conducting
parallel investigations of JPMorgan Chase and Bear
Stearns for possible antitrust and securities
violations in connection with the bidding or sale
of guaranteed investment contracts and derivatives
to municipal issuers. The principal focus of the
investigations to date has been the period 2001 to
2005. A group of state attorney generals and the OCC
also opened investigations into the same underlying
conduct. JPMorgan Chase has been cooperating with
those investigations and has produced documents and
other information.
On March 18, 2008, the Philadelphia Office of the
SEC provided to
JPMorgan Securities a Wells Notice that it
intended to bring civil charges in connection with
its investigations. JPMorgan Securities has
responded to that Wells Notice. It also responded
to a separate Wells Notice that that Office
provided to Bear, Stearns & Co. Inc. (now known as J.P. Morgan
Securities Inc.) on February1, 2008.
In addition, beginning in March 2008, purported
class action lawsuits and individual actions have
been filed against JPMorgan Chase and Bear Stearns,
as well as numerous other providers and brokers
involved in the market for a variety of financial
instruments related to municipal bonds and referred
to collectively by plaintiffs as “municipal
derivatives” (the “Municipal Derivatives
Actions”), for alleged antitrust violations in
connection
with the bidding or sale of “municipal
derivatives.” The MDL Panel ordered the antitrust
actions relating to “municipal derivatives”
coordinated for pretrial proceedings in the United
States District Court for the Southern District of
New York (the “MDL court”). On August 22, 2008,
certain class plaintiffs filed a consolidated class
action complaint alleging violations of Section 1
of the Sherman Act based on the alleged conspiracy
described above. On October 21, 2008, defendants
filed a joint motion to dismiss the consolidated
class action complaint. The MDL court declined to
stay discovery pending disposition of the motions
to dismiss.
There are a number of other actions that are
proceeding separately from the consolidated class
action complaint. These include purported class
actions under the Sherman Act and California state
law as well as individual actions that state
claims solely under California state law. In
addition, there are several actions that have been
noticed as
a tag-along action to the MDL Panel
and are awaiting transfer to the MDL court.
Bear Stearns Hedge Fund Matters. Bear Stearns,
certain of its current or former subsidiaries,
including Bear Stearns Asset Management, Inc.
(“BSAM”) and Bear Stearns & Co. Inc., and certain current or
former employees have been named as defendants
(“Bear Stearns defendants”) in a number of actions
relating to the Bear Stearns High Grade Structured
Credit Strategies Master Fund, Ltd. (the “High
Grade Fund”) and the Bear Stearns High Grade
Structured Credit Strategies Enhanced Leverage
Master Fund, Ltd. (the “Enhanced Leverage Fund”)
(collectively, the “Funds”). BSAM served as
investment manager for both of the Funds, which
were organized such that there were U.S. and Cayman
Islands “feeder funds” that invested substantially
all their assets, directly or indirectly, in the
Funds. The Funds are in liquidation.
The Bear Stearns defendants have been sued in five
civil actions in United States District Court for
the Southern District of New York. The Joint
Voluntary Liquidators of the Cayman Islands feeder funds has filed a complaint asserting claims for,
among other things, fraud, breach of fiduciary
duty, breach of contract, recklessness, gross
negligence, negligence, and unjust enrichment. Also
joining the Liquidators as plaintiffs are two
purported investors in the U.S. feeder funds. In
addition to individual claims, these two plaintiffs
purport to assert derivative actions with the U.S.
feeder funds as nominal defendants and seek damages
of not less than $1.5 billion, unspecified punitive
damages, costs, and fees. Two purported class
action lawsuits have been filed on behalf of
purchasers of partnership interests in the High
Grade and Enhanced Leverage U.S. feeder funds,
respectively. In each such action, the plaintiff
has asserted claims for, among other things, breach
of fiduciary duty. The class action complaints also
purport to assert derivative actions with the High
Grade and
Enhanced Leverage U.S. feeder funds as nominal
defendants. The relief being sought by these
plaintiffs is unspecified damages, costs and fees.
In addition, Bank of America and Banc of America
Securities LLC (together “BofA”) have filed a lawsuit in
United States District Court for the Southern District of New York alleging breach of contract and fraud in connection
with a May 2007 $4 billion dollar securitization,
known as a “CDO-squared,” for which BSAM served as
collateral manager. This securitization was
composed of certain collateralized debt obligation
(“CDO”) holdings that were purchased by BofA from
the High Grade Fund and the Enhanced Leverage Fund.
The Bear Stearns defendants have filed motions to
dismiss each of the four civil actions described
above. Finally, in connection with its investment
and other transactions related to the Enhanced
Leverage Fund, Barclays Bank brought an action
asserting claims for, among other things, fraud,
fraudulent concealment, breach of fiduciary duty,
and negligent misrepresentation. On February 10,2009, Barclays filed a notice of dismissal of that
action against all defendants.
In addition, one or more Bear Stearns defendants
have been named as parties in multiple FINRA
arbitrations initiated by investors in the Funds.
The relief being sought by the claimants in these
matters is compensatory damages, unspecified
punitive damages, costs and expenses.
BSAM and its affiliates have also been contacted
by, and have received requests for information and
documents from, various federal and state
regulatory and law enforcement authorities as part
of their investigations regarding the Funds,
including the SEC, the United States Attorney’s Office for the Eastern
District of New York and the Securities Division of
the Commonwealth of Massachusetts (the “Massachusetts Securities
Division”). On November 14, 2007, the Massachusetts Securities
Division filed an administrative complaint against
BSAM alleging that BSAM violated multiple
provisions of the Massachusetts Securities Act by
failing to adequately disclose and/or manage
conflicts of interest related to procedures for
related party transactions. BSAM submitted an Offer
of Settlement to resolve this matter that was
accepted by the Massachusetts Securities Division, and then
resolved through a Consent Order filed on November13, 2008.
Enron Litigation. JPMorgan Chase and certain of its
officers and directors are involved in a number of
lawsuits arising out of its banking relationships
with Enron Corp. and its subsidiaries (“Enron”).
Several actions and other proceedings against the
Firm have been resolved, including adversary
proceedings brought by Enron’s bankruptcy estate.
In addition, the Firm resolved the lead class
action litigation brought on behalf of the
purchasers of Enron securities, captioned Newby v.
Enron Corp., for approximately $2.2 billion
(pretax), which the Firm funded on October 16, 2008.
The Newby settlement does not resolve Enron-related
actions filed separately by plaintiffs who opted
out of the class action or by certain plaintiffs
who are asserting claims not covered by that
action. Some of these other
actions have been dismissed or settled separately.
The remaining Enron-related actions include three
actions against the Firm by plaintiffs who were
bank lenders or claim to be successors-in-interest
to bank lenders who participated in Enron credit
facilities co-syndicated by the Firm; individual
actions by Enron investors, creditors and
counterparties; and a third-party action brought by
a defendant in an Enron-related case seeking
apportionment of responsibility and contribution
under Texas state law against JPMorgan Chase and
other defendants. Plaintiffs in the bank lender
cases have moved for partial summary judgment, and
JPMorgan Chase has moved for summary judgment
and/or partial judgment on the pleadings. The three
bank lender cases have been transferred to the
United States District Court for the Southern
District of New York.
In March 2006, two plaintiffs filed complaints in
New York Supreme Court against JPMorgan Chase
alleging breach of contract, breach of implied duty
of good faith and fair dealing and breach of
fiduciary duty based upon the Firm’s role as
Indenture Trustee in connection with two indenture
agreements between JPMorgan Chase and Enron. The
Firm removed both actions to the United States
District Court for the Southern District of New
York. The federal court dismissed one of these
cases and remanded the other to New York State
court. JPMorgan Chase filed a motion to dismiss
plaintiffs’ amended complaint in State court on May24, 2007, which was denied. JPMorgan Chase
appealed, and on December 23, 2008, the Supreme
Court, Appellate Division for the First Department
reversed the trial court’s order, dismissing
plaintiffs’ complaint. Plaintiffs have moved for
leave to further appeal this ruling.
In a purported, consolidated class action lawsuit
by JPMorgan Chase stockholders alleging that the
Firm issued false and misleading press releases and
other public documents relating to Enron in
violation of Section 10(b) of the Securities
Exchange Act of 1934 and Rule 10b-5 thereunder, the
United States District Court for the Southern
District of New York dismissed the lawsuit in its
entirety without prejudice in March 2005.
Plaintiffs filed an amended complaint in May 2005.
The Firm moved to dismiss the amended complaint,
which the Court granted with prejudice on March 28,2007. Plaintiffs appealed the dismissal. On January21, 2009, the United States Court of Appeals for
the Second Circuit affirmed the trial court’s
dismissal of the action.
A putative class action on behalf of JPMorgan Chase
employees who participated in the Firm’s 401(k)
plan alleges claims under ERISA for alleged breaches
of fiduciary duties and negligence by JPMorgan
Chase, its directors and named officers. In August
2005, the United States District Court for the
Southern District of New York denied plaintiffs’
motion for class certification and ordered some of
plaintiffs’ claims dismissed. In September 2005,
the Firm moved for summary judgment seeking
dismissal of this ERISA lawsuit in its entirety,
and in September 2006, the Court granted summary
judgment in part, and ordered plaintiffs to show
cause as to why the remaining claims should not be
dismissed. On December 27, 2006, the Court
dismissed the case with prejudice. Plaintiffs
appealed the dismissal. On December 24, 2008, the
United States Court of Appeals for the Second
Circuit reversed the trial court’s dismissal and
remanded the case back to the District Court for
further proceedings.
IPO Allocation Litigation. Beginning in May 2001,
JPMorgan Chase and certain of its securities
subsidiaries were named, along with numerous other
firms in the securities industry, as defendants in
a large number of putative class action lawsuits
filed in the United States District Court for the
Southern District of New York alleging
improprieties in the allocation of securities in
various public offerings, including some offerings
for which a JPMorgan Chase entity served as an
underwriter. They also claim violations of
securities laws arising from alleged material
misstatements and omissions in registration
statements and prospectuses for the initial public
offerings (“IPOs”) and alleged market manipulation
with respect to aftermarket transactions in the
offered securities. The securities lawsuits allege,
among other things, misrepresentation and market
manipulation of the aftermarket trading for these
offerings by tying allocations of shares in IPOs to
undisclosed excessive commissions paid to the
underwriter defendants, including JPMorgan
Securities, and to required aftermarket purchase
transactions by customers who received allocations
of shares in the respective IPOs, as well as
allegations of misleading analyst reports. Bear,
Stearns & Co., Inc. is named as a defendant in 95
of the pending IPO securities cases. Antitrust
lawsuits based on similar allegations have been
dismissed with prejudice.
The District Court denied a motion to dismiss in
all material respects relating to the underwriter
defendants and generally granted plaintiffs’ motion
for class certification in six “focus cases.” The
U.S. Court of Appeals for the Second Circuit
reversed the District Court’s order granting class
certification, denied plaintiffs’ applications for
rehear-
ing and rehearing en banc, and remanded. On August14, 2007, plaintiffs amended their complaints in the
six “focus cases” as well as their master
allegations for all such cases to reflect new
class-related allegations. On September 27, 2007,
plaintiffs filed a new motion for class
certification in the District Court, and on
November 14, 2007, JPMorgan Securities and the
other defendants moved to dismiss the amended
complaints. Following a mediation, a settlement in
principle has been reached, subject to negotiation
of definitive documentation and court approval. It
has now been publicly reported by others that the
aggregate total of the amounts agreed to be paid by
or on behalf of all issuer and underwriter
defendants, including Lehman Brothers, Inc., which
is now in bankruptcy proceedings, totaled $610
million. JPMorgan Securities’ share of the
settlement will not
have a material adverse effect on the consolidated
financial condition of the Firm.
JPMorgan Securities is also among numerous
underwriting firms named as defendants in a number
of complaints filed commencing October 3, 2007, in
the United States District Court for the Western District
of Washington under Section 16(b) of the
Securities and Exchange Act of 1934 in connection
with the IPO of securities for 23 issuers. Bear
Stearns was named in complaints in connection with
four issuers. Motions to dismiss have been fully
briefed but have not been decided by the Court.
Interchange
Litigation. On June 22, 2005, a group of
merchants filed a putative class action complaint
in the United States District Court for the
District of Connecticut. The complaint alleged that
VISA, MasterCard, Chase Bank USA, N.A., and
JPMorgan Chase, as well as certain other banks, and
their respective bank holding companies, conspired
to set the price of credit card interchange fees in
violation of Section 1 of the Sherman Act. The
complaint further alleged tying/bundling and
exclusive dealing. Since the filing of the
Connecticut complaint, other complaints were filed
in different United States District Courts
challenging the setting of interchange, as well as
the card associations’ respective rules. All cases
have been consolidated in the Eastern District of
New York for pretrial proceedings. An amended
consolidated class action complaint was filed on
April 24, 2006, that incorporated the interchange
claims, described the alleged anticompetitive
effects of card associations’ rules and extended
claims beyond credit to debit cards. Defendants
filed a motion to dismiss all claims that predated
January 1, 2004. On January 8, 2008, the Court
granted the motion to dismiss these claims. On
January 30, 2009, a second amended consolidated class
action complaint was served. The basic theories of
the complaint remain the same. Fact discovery has
closed, and expert discovery in the case is
ongoing. The plaintiffs have filed a motion seeking
class certification, and the defendants have
opposed that motion. The Court has not yet ruled on
the class certification motion.
In addition to the consolidated class action
complaint, plaintiffs filed supplemental complaints
challenging the MasterCard and Visa IPOs. With
respect to MasterCard, plaintiffs first filed a
supplemental complaint in May 2006 alleging that
the offering violated Section 7 of the Clayton Act
and Section 1 of the Sherman Act and that the
offering was a fraudulent conveyance. Defendants
filed a motion to dis-
miss both of those claims. After the issues were
fully briefed, on November 25, 2008, the District
Court dismissed the supplemental complaint with
leave to replead. On January 30, 2009, the
plaintiffs filed and served an amended supplemental
complaint again challenging the MasterCard IPO,
making antitrust claims similar to those that were
set forth in the original supplemental complaint,
as well as the fraudulent conveyance claim. With
respect to the Visa IPO, on
January 30, 2009, the plaintiffs filed a
supplemental complaint challenging the Visa IPO on
antitrust theories parallel to those articulated in
the MasterCard IPO pleading.
Mortgage-Backed Securities Litigation. JPMorgan
Securities, J.P. Morgan Acceptance Corp I (“JPMAC”)
and 32 trusts that issued Mortgage Pass-Through
Certificates and Asset-Backed Pass-Through
Certificates, for which JPMorgan Securities served as underwriter
and JPMAC as depositor, as well as certain officers
and/or directors of JPMAC, are defendants in a
purported class action suit commenced on March 26,2008, in State court in New York. The suit was
subsequently removed by defendants to the United
States District Court for the Eastern District of
New York. Plaintiffs, two employee benefit plans,
assert claims for violations of the federal
securities laws alleging that the disclosures in
the offering materials for the certificates issued
by the 32 trusts contained material misstatements
and omissions, particularly as to mortgage
origination standards and the risk profile of the
investment. The complaint seeks unspecified damages
and rescission. Pursuant to a stipulation among the
parties, plaintiffs are to serve an amended
complaint by March 9, 2009.
A purported class action suit was commenced on
August 20, 2008, against Bear, Stearns & Co. Inc.
and certain of its subsidiaries and former
employees in New York Supreme Court on behalf of
purchasers of certificates issued in an offering of
Mortgage Loan Pass-Through Certificates. JPMorgan
Chase is also named as a defendant solely in its
alleged capacity as successor-in-interest to Bear,
Stearns & Co. Inc. Plaintiff also asserts claims
for violations of the federal securities laws,
claiming the offering materials for the
certificates allegedly contained material
misstatements and omissions with respect to, among
other things, mortgage origination standards and
the risk profile of the investment. Plaintiff seeks
recovery of unspecified compensatory damages and
rescission. The defendants have removed this action
to the District Court for the Southern District of
New York.
Two purported nationwide class actions alleging
violations of the federal securities laws in
connection with the sale of mortgage-backed
securities have also been brought against
Washington Mutual Bank and certain of its former
subsidiaries by three employee retirement plans.
The first case (the “State-Filed Action”) was filed
in the Superior Court of the State Washington,
County of King on August 4, 2008, against
Washington Mutual Bank; three former Washington
Mutual Bank subsidiaries that are now subsidiaries
of JPMorgan Chase Bank, N.A. (WaMu Asset Acceptance
Corp., WaMu Capital Corp., Washington Mutual
Mortgage Securities Corp.); and four former
Washington Mutual Bank employees (some of whom are
now JPMorgan Chase employees). The plaintiffs in
this case allege that defendants made false and
misleading statements and omissions relating to
mortgage origination and underwriting standards in
offering materials for Mortgage Pass-Through
certificates, backed by
pools of
Washington Mutual Bank-originated, first-lien, prime mortgages. Plaintiffs also allege that
defendants failed to disclose Washington Mutual
Bank’s alleged coercion of or collusion with
appraisal vendors to inflate appraisal valuations
and thus misrepresented the loan-to-value ratios
of, and the adequacy of appraisals supporting, the
loans in the pools. On January 28, 2009, the state
court issued an order substituting the FDIC as
defendant for Washington Mutual Bank. On January29, 2009, the FDIC removed this action to the
United States District Court for the Western
District of Washington. On February 5, 2009, the
FDIC moved to stay the State-Filed Action pending
completion of the FDIC’s administrative review of
plaintiff’s claims.
The second case (the “Federal-Filed Action”) filed
on January 12, 2009, is pending in the United
States District Court for the Western District of
Washington in Seattle against Washington Mutual
Bank, WaMu Asset Acceptance Corp., WaMu Capital
Corp., the same individuals named in the
State-Filed Action, and 19 securitization trusts. The
plaintiff in the Federal-Filed Action makes similar
allegations to the State-Filed Action, but does not
specifically challenge defendants’ appraisal
practices. On February 10, 2009, the Court in the
Federal-Filed Action ordered that the FDIC be
substituted as defendant for Washington Mutual
Bank. On February 12, 2009, the FDIC moved to
dismiss it from the Federal-Filed Action without
prejudice because plaintiffs failed to exhaust
administrative remedies before filing their
lawsuit. On February 19, 2009, the non-FDIC defendants moved in the
Federal-Filed Action to consolidate that action with the State-Filed
Action.
EMC
Mortgage Corporation (“EMC”), a subsidiary of
JPMorgan Chase, has been named as a defendant in an
action commenced on November 5, 2008, in the United
States District Court for the Southern District of
New York, by Ambac Assurance Corp., a mono-line
bond insurer that guaranteed payment on certain
classes of mortgage-backed securities issued by
EMC. This lawsuit involves four EMC
securitizations. Plaintiff claims the loans that
served as collateral for the four transactions had
origination defects that purportedly violate
certain representations and warranties given by EMC
to plaintiff and that EMC has breached the relevant
agreements between the parties by failing to
repurchase allegedly defective mortgage loans.
Plaintiff seeks unspecified damages and an order
compelling EMC to repurchase individual loans that
are allegedly in breach of EMC’s representations
and warranties.
In addition, the Firm has been named as a
defendant in its capacity as an underwriter for
other issuers in other litigation involving
mortgage-backed securities.
Auction-Rate Securities Investigations and
Litigation. Beginning in March 2008, several
regulatory authorities initiated investigations of
a number of industry participants, including the
Firm, concerning possible state and federal
securities law violations in connection with the
sale of auction-rate securities. The market for
many such securities had frozen and a significant
number of auctions for those securities began to
fail in
February 2008. Multiple state and federal agencies,
including the SEC, the Financial Industry
Regulatory Authority (“FINRA”), the Attorney General
of the State of New York, the State of Florida
Office of Financial Regulation, on behalf of the
North American Securities
Administrators
Association (“NASAA”), and the
Massachusetts Attorney General, have either
requested information from JPMorgan Chase or issued
subpoenas to JPMorgan Chase regarding the
activities of its affiliates with respect to
auction-rate securities.
On August 13, 2008, the Firm, on behalf of itself
and affiliates, agreed to a settlement in principle
with the New York Attorney General’s Office which
provided, among other things, that the Firm would
offer to purchase at par certain auction-rate
securities purchased from JPMorgan Securities,
Chase Investment Services Corp. and Bear, Stearns &
Co. Inc. by individual investors, charities, and
small- to medium-sized businesses with account
values of up to $10 million no later than November12, 2008. On August 14, 2008, the Firm agreed to a
substantively similar settlement in principle with
the Office of Financial Regulation for the State of
Florida and NASAA Task Force, which agreed
to recommend approval of the settlement to all
remaining states, Puerto Rico and the U.S. Virgin
Islands. The agreements in principle provide for
the payment of penalties totaling $25 million to
New York and the other states.
JPMorgan Chase is currently in the process of
negotiating final settlement documentation with
the New York Attorney General’s Office and the
Office of Financial Regulation for the State of
Florida. JPMorgan Chase has cooperated, and will
continue to cooperate, with the ongoing SEC’s
investigation.
On October 17, 2008, following an investigation by
FINRA into auction-rate securities practices of
WaMu Investments Inc., a former Washington Mutual
Bank subsidiary acquired by the Firm in the
Washington Mutual transaction. WaMu Investments,
Inc. resolved the matter by submitting a Letter of
Acceptance, Waiver and Consent to FINRA. Without
admitting or denying the findings, WaMu
Investments, Inc. consented to findings by FINRA
that it violated certain NASD Rules relating to
communications with the public and supervisory
procedures and, among other things, agreed to offer
to purchase at par auction-rate securities
purchased by certain WaMu Investments, Inc.
customers and to pay a fine of $250,000.
The Firm is the subject of two putative securities
class actions in the United States District Court
for the Southern District of New York and a number
of individual arbitrations and lawsuits relating to
the Firm’s sales of auction-rate securities. Each
complaint alleges that JPMorgan Chase marketed
auction-rate securities as safe, liquid, short-term
investments although it knew that auction-rate
securities were long-dated debt instruments. The
complaints also allege that JPMorgan Chase and
other broker-dealers artificially supported the
auction-rate securities market and that JPMorgan Chase knew
that the market would become illiquid if the firms
stopped supporting the auctions but did not
disclose this fact to investors. Each of the named
plaintiffs in these actions accepted JPMorgan
Chase’s buy-back offer as part of its settlement
with the regulatory agencies and no longer owns any
auction-rate securities. Judge Berman of the United
States District Court for the Southern District of
New York consolidated the two putative securities
class actions and appointed lead plaintiffs and
lead counsel involving the sale of auction-rate
securities. One of the groups of plaintiffs
previously seeking lead
plaintiff status filed a motion for
reconsideration of the Court’s order. The motion
for reconsideration has been fully briefed and is
pending before the Court.
Additionally, the Firm is the subject of two
putative antitrust class actions in the United
States District Court for the Southern District of
New York, which actions allege that the Firm, in
collusion with numerous other financial institution
defendants, entered into an unlawful conspiracy in
violation of Section 1 of the Sherman Act.
Specifically, the complaints allege that defendants
acted collusively to maintain and stabilize the
auction-rate securities market and similarly acted
collusively in withdrawing their support for the
auction-rate securities market in February 2008.
JPMorgan Chase and the other defendants filed a
joint motion to dismiss both actions. Plaintiffs’
opposition to the motion is due on March 19, 2009.
In addition to the various cases, proceedings and
investigations discussed above, JPMorgan Chase and
its subsidiaries are named as defendants or
otherwise involved in a number of other legal
actions and governmental proceedings arising in
connection with their businesses. Additional
actions, investigations or proceedings may be
initiated from time to time in the future. In view
of the inherent difficulty
of predicting the outcome of legal matters,
particularly where the claimants seek very large or
indeterminate damages, or where the cases present
novel legal theories, involve a large number of
parties or are in early stages of discovery, the
Firm cannot state with confidence what the eventual
outcome of these pending matters will be, what the
timing of the ultimate resolution of these matters
will be or what the eventual loss, fines, penalties
or impact related to each pending matter may be.
JPMorgan Chase believes, based upon its current
knowledge, after consultation with counsel and
after taking into account its current litigation
reserves, that the outcome of the legal actions,
proceedings and investigations currently pending
against it should not have a material adverse
effect on the Firm’s consolidated financial
condition. However, in light of the uncertainties
involved in such proceedings, actions and
investigations, there is no assurance that the
ultimate resolution of these matters will not
significantly exceed the reserves currently accrued
by the Firm; as a result, the outcome of a
particular matter may be material to JPMorgan
Chase’s operating results for a particular period,
depending on, among other factors, the size of the
loss or liability imposed and the level of JPMorgan
Chase’s income for that period.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Chairman of the Board since December 31, 2006, and President and Chief
Executive Officer since December 31, 2005. He had been President and Chief
Operating Officer from July 1, 2004, until December 31, 2005. Prior to the
merger between JPMorgan Chase & Co. and Bank One Corporation (the
“Merger”), he had been Chairman and Chief Executive Officer of Bank One
Corporation.
Frank J. Bisignano
49
Chief Administrative Officer since December 2005. Prior to joining JPMorgan
Chase, he had been Chief Executive Officer of Citigroup Inc.’s Global
Transaction Services.
Steven D. Black
56
Co-Chief Executive Officer of the Investment Bank since March 2004, prior to
which he had been Deputy Head of the Investment Bank.
Chief Financial Officer since September 2004, prior to which he had been Head
of Middle Market Banking. Prior to the Merger, he had been Chief
Administrative Officer of Commercial Banking and Chief Operating Officer of
Middle Market Banking at Bank One Corporation.
Stephen M. Cutler
47
General Counsel since February 2007. Prior to joining JPMorgan Chase, he was
a partner and co-chair of the Securities Department at the law firm of
WilmerHale since October 2005. Prior to joining WilmerHale, he had been
Director of the Division of Enforcement at the U.S. Securities and Exchange
Commission since October 2001.
William M. Daley
60
Head of Corporate Responsibility since June 2007 and Chairman of the
Midwest Region since May 2004. Prior to joining JPMorgan Chase, he had been
President of SBC Communications.
Chief Investment Officer since February 2005, prior to which she was Head of
Global Treasury.
Samuel Todd Maclin
52
Head of Commercial Banking since July 2004, prior to which he had been
Chairman and CEO of the Texas Region and Head of Middle Market Banking.
Jay Mandelbaum
46
Head of Strategy and Business Development. Prior to the Merger, he had been
Head of Strategy and Business Development since September 2002 at Bank
One Corporation.
Heidi Miller
55
Chief Executive Officer of Treasury & Securities Services. Prior to the Merger, she
had been Chief Financial Officer at Bank One Corporation.
Charles W. Scharf
43
Chief Executive Officer of Retail Financial Services. Prior to the Merger, he had
been Head of Retail Banking at Bank One Corporation.
Gordon A. Smith
50
Chief Executive Officer of Card Services since June 2007. Prior to joining
JPMorgan Chase, he was with American Express Company for more than 25
years. From August 2005 until June 2007, he was president of American
Express’ global commercial card business. Prior to that, he was president of the
consumer card services group and was responsible for all consumer card products in the U.S.
James E. Staley
52
Chief Executive Officer of Asset Management.
William T. Winters
47
Co-Chief Executive Officer of the Investment Bank since March 2004, prior to
which he had been Deputy Head of the Investment Bank and Head of Credit &
Rate Markets.
Barry L. Zubrow
55
Chief Risk Officer since November 2007. Prior to joining JPMorgan Chase, he
was a private investor and has been Chairman of the New Jersey Schools
Development Authority since March 2006; prior to November 2003 he held a
variety of positions at The Goldman Sachs Group, including Chief Administrative
Officer from 1999.
Unless otherwise noted, during the five fiscal years ended December 31, 2008, all of JPMorgan
Chase’s above-named executive officers have continuously held senior-level positions with JPMorgan
Chase or its predecessor institution, Bank One Corporation prior to
the Merger. There are no family relationships among
the foregoing executive officers.
Part II
ITEM 5:
MARKET FOR REGISTRANT’S COMMON
EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
The outstanding shares of JPMorgan Chase common
stock are listed and traded on the New York Stock
Exchange, the London Stock Exchange Limited and the
Tokyo Stock Exchange. For the quarterly high and
low prices of JPMorgan Chase’s common stock on the
New York Stock Exchange for the last two years, see
the section entitled “Supplementary information –
Selected quarterly financial data (unaudited)” on
page 217. For a comparison of the cumulative total
return for JPMorgan Chase common stock with the
comparable total return of the S&P 500 Index and
the S&P Financial Index over the five-year period
ended December 31, 2008, see “Five-year stock
performance,” on page 27.
On
February 23, 2009, the Board of Directors reduced the Firm's
quarterly common stock dividend from $0.38 to $0.05 per share,
effective for the dividend payable April 30, 2009 to
shareholders of record on April 6, 2009.
JPMorgan Chase declared
quarterly cash dividends on its common stock in the
amount of $0.38 for each quarter of 2008 and the
second, third and fourth quarters of 2007, and $0.34 per share for the first quarter of 2007 and
for each quarter of 2006. The common dividend
payout ratio, based upon reported net income, was
114% for 2008, and 34% for both 2007 and 2006. For
a discussion
of restrictions on dividend payments,
see Note 24 on pages 193–194 and for additional information
regarding the reduction of the dividend, see page 32.
At January 31, 2009,
there were 233,908 holders of record of JPMorgan
Chase common stock.
On April 17, 2007, the Board of Directors authorized
the repurchase of up to $10.0 billion of the Firm’s
common shares, which supercedes an $8.0 billion
repurchase program approved in 2006. The $10.0
billion authorization includes shares to be
repurchased to offset issuances under the Firm’s
employee stock-based plans. The actual number of
shares repurchased is subject to various factors,
including market conditions; legal considerations
affecting the amount and timing of repurchase
activity; the Firm’s capital position (taking into
account goodwill and intangibles); internal capital
generation; and alternative potential investment
opportunities. The repurchase program does not
include specific price targets or timetables, may
be executed through open market purchases or
privately negoti-
ated transactions, or utilizing a written
trading plan under Rule 10b5-1 of the Securities
Exchange Act of 1934, and may be suspended at any
time. A Rule 10b5-1 repurchase plan allows the Firm
to repurchase shares during periods when it would
not otherwise be repurchasing common stock, for
example during internal trading “black-out periods.” All purchases under a Rule 10b5-1 plan must be
made according to a predefined plan that is
established when the Firm is not aware of material
nonpublic information.
In order to maintain its capital objectives, the
Firm did not repurchase any shares during the
fourth quarter and full year of 2008, under the
current $10.0 billion stock repurchase program. As
of December 31, 2008, $6.2 billion of authorized
repurchase capacity remained under the current
stock repurchase program. For a discussion of
restrictions on stock repurchases, see Capital
Purchase Program on page 72 and Note 24 on pages
193–194.
Stock repurchases under the stock-based incentive plans
Participants in the Firm’s stock-based incentive
plans may have shares withheld to cover income
taxes. Shares withheld to pay income taxes are
repurchased pursuant to the terms of the applicable
plan and not under the Firm’s share repurchase
program. Shares repurchased after October 28, 2008,
were repurchased in accordance with an exemption
from the Capital Purchase Program’s stock
repurchase restrictions. Shares repurchased
pursuant to these plans during 2008 were as
follows:
For five-year selected financial data, see
“Five-year summary of consolidated financial
highlights (unaudited)” on page 26 and “Selected
annual financial data (unaudited)” on page 218.
ITEM 7: MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management’s discussion and analysis of
financial condition and results of operations,
entitled “Management’s discussion and analysis,” appears on pages 27 through 114. Such information
should be read in conjunction with the
consolidated financial statements and notes
thereto, which appear on pages 118 through 216.
ITEM 7A: QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
For information related to market risk,
see the “Market Risk Management” section on
pages 99 through 104.
ITEM 8: FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA
The consolidated financial statements, together
with the notes thereto and the report of
PricewaterhouseCoopers LLP dated February 27, 2009,
thereon, appear on pages 117 through 216.
Supplementary financial data for each full quarter
within the two years ended December 31, 2008, are
included on page 217 in the table entitled
“Supplementary information – Selected quarterly
financial data (unaudited).” Also included is a
“Glossary of terms’’ on pages 219–222.
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A: CONTROLS AND PROCEDURES
As of the end of the period covered by this
report, an evaluation was carried out under the
supervision and with the participation of the
Firm’s management, including its Chairman and Chief
Executive Officer and its Chief Financial Officer,
of the effectiveness of its disclosure controls and
procedures (as defined in Rule 13a-15(e) under the
Securities Exchange Act of 1934). Based upon that
evaluation, the Chairman and Chief Executive
Officer and the Chief Financial Officer concluded
that these disclosure controls and procedures were
effective. See Exhibits 31.1 and 31.2 for the
Certification statements issued by the Chairman and
Chief Executive Officer and Chief Financial
Officer.
The Firm is committed to maintaining high standards
of internal control over financial reporting.
Nevertheless, because of its inherent limitations,
internal control over financial reporting may not
prevent or detect misstatements. In addition, in a
firm as large and complex as JPMorgan Chase, lapses
or deficiencies in internal controls may occur from
time to time, and there can be no assurance that
any such deficiencies will not result in
significant deficiencies – or even material
weaknesses – in internal controls in the
future. See page 116 for “Management’s report on
internal control over financial reporting.” There
was no change in the Firm’s internal control over
financial reporting (as defined in Rule 13a-15(f)
under the Securities Exchange Act of 1934) that
occurred during the fourth quarter of 2008 that has
materially affected, or is reasonably likely to
materially affect, the Firm’s internal control over
financial reporting.
ITEM 10:
DIRECTORS, EXECUTIVE OFFICERS AND
CORPORATE GOVERNANCE
See Item 13 below.
ITEM 11: EXECUTIVE COMPENSATION
See Item 13 below.
ITEM 12: SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS
For security ownership of certain beneficial
owners and management, see Item 13 below.
The following table details the total number of shares available for issuance under JPMorgan
Chase’s employee stock-based incentive plans (including shares available for issuance to
nonemployee directors). The Firm is not authorized to grant stock-based incentive awards to
nonemployees other than to nonemployee directors.
Represents future shares available under the shareholder-approved 2005 Long-Term Incentive
Plan, as amended and restated effective May 20, 2008.
All future shares will be issued under the shareholder-approved 2005 Long-Term Incentive Plan,
as amended and restated effective May 20, 2008. For further information see Note 10 on pages
155–158.
ITEM 13: CERTAIN RELATIONSHIPS AND
RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE
Information to be provided in Items 10, 11, 12, 13
and 14 of Form 10-K and not otherwise included
herein is incorporated by reference to the Firm’s
definitive proxy statement for its 2008 Annual
Meeting of Stockholders to be held on May 19, 2009,
which will be filed with the SEC within 120 days of
the end of the Firm’s fiscal year ended December31, 2008.
ITEM 14: PRINCIPAL ACCOUNTING FEES
SERVICES
See Item 13 above.
Part IV
ITEM 15: EXHIBITS, FINANCIAL STATEMENT
SCHEDULES
Exhibits, financial statement schedules
1.
Financial statements
The Consolidated financial statements, the Notes thereto and the report thereon listed in Item 8
are set forth commencing on page 18.
Certificate of Designations of Fixed-to-Floating Rate Non-Cumulative Preferred Stock, Series I
(incorporated by reference to Exhibit 3.1 to the Current Report on Form 8-K of JPMorgan Chase & Co.
(File No. 1-5805) filed April 24, 2008).
3.3
Certificate of Designations of 6.15% Cumulative Preferred Stock, Series E (incorporated by
reference to Exhibit 3.1 to the Current Report on Form 8-K of JPMorgan Chase & Co. (File No.
1-5805) filed July 16, 2008).
Certificate of Designations of 5.72% Cumulative Preferred Stock, Series F (incorporated by
reference to Exhibit 3.2 to the Current Report on Form 8-K of JPMorgan Chase & Co. (File No.
1-5805) filed July 16, 2008).
3.5
Certificate of Designations of 5.49% Cumulative Preferred Stock, Series G (incorporated by
reference to Exhibit 3.3 to the Current Report on Form 8-K of JPMorgan Chase & Co. (File No.
1-5805) filed July 16, 2008).
3.6
Certificate of Designations of 8.625% Non-Cumulative Preferred Stock, Series J (incorporated
by reference to Exhibit 3.1 to the Current Report on Form 8-K/A of JPMorgan Chase & Co. (File No.
1-5805) filed September 17, 2008).
3.7
Certificate of Designations of Fixed Rate Cumulative Preferred Stock, Series K (incorporated
by reference to Exhibit 3.1 to the Current Report on Form 8-K of JPMorgan Chase & Co. (File No.
1-5805) filed October 31, 2008).
Indenture, dated as of December 1, 1989, between Chemical Banking Corporation (now known as
JPMorgan Chase & Co.) and The Chase Manhattan Bank (National Association) (succeeded by Deutsche
Bank Trust Company Americas), as Trustee.
4.1(b)
First Supplemental Indenture, dated as of November 1, 2007, between JPMorgan Chase & Co. and
Deutsche Bank Trust Company Americas, as Trustee, to the Indenture,
dated as of December 1, 1989
(incorporated by reference to Exhibit 4.1 to the Current Report
on Form 8-K of JPMorgan Chase & Co. (File No. 1-5805) filed November 7, 2007).
4.1(c)
Fifth Supplemental Indenture, dated as of December 22, 2008, between JPMorgan Chase & Co.
and Deutsche Bank Trust Company Americas, as Trustee, to the
Indenture, dated as of December 1, 1989.
4.2(a)
Indenture, dated as of April 1, 1987, as amended and restated as of December 15, 1992,
between Chemical Banking Corporation (now known as JPMorgan Chase & Co.) and Morgan Guaranty Trust
Company of New York (succeeded by U.S. Bank Trust National Association), as Trustee (incorporated
by reference to Exhibit 4.3(a) to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No.
1-5805) for the year ended December 31, 2005).
4.2(b)
Third Supplemental Indenture, dated as of December 29, 2000, between The Chase Manhattan
Corporation (now known as JPMorgan Chase & Co.) and U.S. Bank Trust National Association, as
Trustee, to the Indenture, dated as of April 1, 1987, as amended and restated as of December 15,1992 (incorporated by reference to Exhibit 4.3(c) to the Annual Report on Form 10-K of JPMorgan
Chase & Co. (File No. 1-5805) for the year ended December 31, 2005).
4.3(a)
Indenture, dated as of May 25, 2001, between J.P. Morgan Chase & Co. and Bankers Trust
Company (succeeded by Deutsche Bank Trust Company Americas), as Trustee (incorporated by reference
to Exhibit 4(a)(1) to the Registration Statement on Form S-3 of J.P. Morgan Chase & Co. (File No.
333-52826) filed June 13, 2001).
Junior Subordinated Indenture, dated as of December 1, 1996, between The Chase Manhattan
Corporation (now known as JPMorgan Chase & Co.) and The Bank of New York (succeeded by The Bank of
New York Mellon), as Trustee.
Supplemental Indenture (Second), dated as of May 19, 2005, between JPMorgan Chase & Co. and
The Bank of New York (succeeded by The Bank of New York Mellon), as Debenture Trustee, to the
Junior Subordinated Indenture, dated as of December 1, 1996 (incorporated by reference to Exhibit
4.3 to the Registration Statement on Form S-3 of JPMorgan Chase & Co. (File No. 333-126750) filed July 21, 2005.
Other instruments defining the rights of holders of long-term debt securities of JPMorgan
Chase & Co. and its subsidiaries are omitted pursuant to Section (b)(4)(iii)(A) of Item 601 of
Regulation S-K. JPMorgan Chase & Co. agrees to furnish copies of these instruments to the SEC upon
request.
10.1
Deferred Compensation Plan for Non-Employee Directors of JPMorgan Chase & Co., as amended and
restated July 2001 and as of December 31, 2004 (incorporated by reference to Exhibit 10.1 to the
Annual Report on Form 10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2007). *
10.2
2005 Deferred Compensation Plan for Non-Employee Directors of JPMorgan Chase & Co., effective
as of January 1, 2005 (incorporated by reference to Exhibit 10.2 to the Annual Report on Form 10-K
of JPMorgan Chase & Co. (File No. 1-5805) for the year
ended December 31, 2007). *
Post-Retirement Compensation Plan for Non-Employee Directors of The Chase Manhattan
Corporation, as amended and restated, effective May 21, 1996. *
10.4
2005 Deferred Compensation Program of JPMorgan Chase & Co., restated effective as of December 31, 2008. *
10.5
JPMorgan Chase & Co. 2005 Long-Term Incentive Plan as
amended and restated effective May 20, 2008 (incorporated by
reference to Appendix B of
Schedule 14A of JPMorgan Chase & Co. (File No. 1-5805)
filed March 31, 2008). *
Excess Retirement Plan of JPMorgan Chase & Co., restated and amended as of December 31, 2008.
*
10.8
1995 Stock Incentive Plan of J.P. Morgan & Co. Incorporated and Affiliated Companies, as
amended, dated December 11, 1996. *
10.9
Executive Retirement Plan of JPMorgan Chase & Co., as amended and restated December 31, 2008.*
10.10
Amendment to Bank One Corporation Director Stock Plan, as amended and restated effective
February 1, 2003. *
10.11
Summary of Bank One Corporation Director Deferred Compensation Plan (incorporated by
reference to Exhibit 10.19 to the Annual Report on Form 10-K of JPMorgan Chase & Co. (File No.
1-5805) for the year ended December 31, 2005). *
10.12
Bank One Corporation Stock Performance Plan, as amended and restated effective February 20,2001. *
10.13
Bank One Corporation Supplemental Savings and Investment Plan, as amended and restated
effective December 31, 2008. *
10.14
Revised and Restated Banc One Corporation 1989 Stock Incentive Plan, effective January 18,
1989. *
10.15
Banc One Corporation Revised and Restated 1995 Stock Incentive Plan, effective April 17,1995. *
10.16
Form of JPMorgan Chase & Co. Long-Term Incentive Plan
Award Agreement of January 2005 stock appreciation rights
(incorporated by reference to Exhibit 10.31 to the Annual Report on Form 10-K
of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2005). *
10.17
Form of JPMorgan Chase & Co. Long-Term Incentive Plan Award Agreement of October 2005 stock
appreciation rights (incorporated by reference to Exhibit 10.33 to the Annual Report on Form 10-K
of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2005). *
10.18
Form of JPMorgan Chase & Co. Long-Term Incentive Plan Award Agreement of January 22, 2008
stock appreciation rights (incorporated by reference to Exhibit 10.25 to the Annual Report on Form
10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2007). *
10.19
Form of JPMorgan Chase & Co. Long-Term Incentive Plan Award Agreement of January 22, 2008
restricted stock units (incorporated by reference to Exhibit 10.26 to the Annual Report on Form
10-K of JPMorgan Chase & Co. (File No. 1-5805) for the year ended December 31, 2007). *
10.20
Form of JPMorgan Chase & Co. Long-Term Incentive Plan Terms and Conditions for stock
appreciation rights, dated as of January 20, 2009. *
10.21
Form of JPMorgan Chase & Co. Long-Term Incentive Plan Terms and Conditions for Operating
Committee member stock appreciation rights, dated as of January 20, 2009. *
10.22
Form of JPMorgan Chase & Co. Long-Term Incentive Plan Terms and Conditions for restricted
stock units, dated as of January 20, 2009. *
10.23
Form of JPMorgan Chase & Co. Long-Term Incentive Plan Terms and Conditions for Operating
Committee member restricted stock units, dated as of January 20, 2009. *
Letter Agreement, including the Securities Purchase Agreement-Standard Terms incorporated
therein, dated October 26, 2008, between JPMorgan Chase & Co. and the United States Department of
the Treasury (incorporated by reference to Exhibit 99.1 to the Current Report on Form 8-K of
JPMorgan Chase & Co. (File No. 1-5805) filed October 31, 2008).
Annual Report on Form 11-K of The JPMorgan Chase 401(k) Savings Plan for the year ended
December 31, 2008 (to be filed pursuant to Rule 15d-21 under the Securities Exchange Act of 1934).
23.1
Consent of independent registered public accounting firm.
31.1
Certification.
31.2
Certification.
32
Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
*
This exhibit is a management contract or
compensatory plan or arrangement.
Provision
for credit losses – accounting conformity(a)
1,534
—
—
—
858
Total noninterest expense
43,500
41,703
38,843
38,926
34,336
Income from continuing operations before income tax expense (benefit)
2,773
22,805
19,886
11,839
5,856
Income tax expense (benefit)(b)
(926
)
7,440
6,237
3,585
1,596
Income from continuing operations
3,699
15,365
13,649
8,254
4,260
Income from discontinued operations(c)
—
—
795
229
206
Income before extraordinary gain
3,699
15,365
14,444
8,483
4,466
Extraordinary gain(d)
1,906
—
—
—
—
Net income
$
5,605
$
15,365
$
14,444
$
8,483
$
4,466
Per common share
Basic earnings per share
Income from continuing operations
$
0.86
$
4.51
$
3.93
$
2.36
$
1.51
Net income
1.41
4.51
4.16
2.43
1.59
Diluted earnings per share
Income from continuing operations
$
0.84
$
4.38
$
3.82
$
2.32
$
1.48
Net income
1.37
4.38
4.04
2.38
1.55
Cash dividends declared per share
1.52
1.48
1.36
1.36
1.36
Book value per share
36.15
36.59
33.45
30.71
29.61
Common shares outstanding
Average: Basic
3,501
3,404
3,470
3,492
2,780
Diluted
3,605
3,508
3,574
3,557
2,851
Common shares at period-end
3,733
3,367
3,462
3,487
3,556
Share price(e)
High
$
50.63
$
53.25
$
49.00
$
40.56
$
43.84
Low
19.69
40.15
37.88
32.92
34.62
Close
31.53
43.65
48.30
39.69
39.01
Market capitalization
117,695
146,986
167,199
138,387
138,727
Selected ratios
Return on common equity (“ROE”):
Income from continuing operations
2
%
13
%
12
%
8
%
6
%
Net income
4
13
13
8
6
Return on assets (“ROA”):
Income from continuing operations
0.21
1.06
1.04
0.70
0.44
Net income
0.31
1.06
1.10
0.72
0.46
Overhead ratio
65
58
63
72
80
Tier 1 capital ratio
10.9
8.4
8.7
8.5
8.7
Total capital ratio
14.8
12.6
12.3
12.0
12.2
Tier 1 leverage ratio
6.9
6.0
6.2
6.3
6.2
Selected balance sheet data (period-end)
Trading assets
$
509,983
$
491,409
$
365,738
$
298,377
$
288,814
Securities
205,943
85,450
91,975
47,600
94,512
Loans
744,898
519,374
483,127
419,148
402,114
Total assets
2,175,052
1,562,147
1,351,520
1,198,942
1,157,248
Deposits
1,009,277
740,728
638,788
554,991
521,456
Long-term debt
252,094
183,862
133,421
108,357
95,422
Common stockholders’ equity
134,945
123,221
115,790
107,072
105,314
Total stockholders’ equity
166,884
123,221
115,790
107,211
105,653
Headcount
224,961
180,667
174,360
168,847
160,968
(a)
Results for 2008 and 2004 included an accounting conformity loan loss reserve provision
related to the acquisition of Washington Mutual Bank’s banking operations and the merger with Bank
One Corporation, respectively.
(b)
The income tax benefit in 2008 is the result of the release of previously established deferred
tax liabilities on non-U.S. earnings and business tax credits.
(c)
On October 1, 2006, JPMorgan Chase & Co. completed the exchange of selected corporate trust
businesses for the consumer, business banking and middle-market banking businesses of The Bank of
New York Company Inc. The results of operations of these corporate trust businesses are being
reported as discontinued operations for each of the periods presented.
(d)
Effective September 25, 2008, JPMorgan Chase acquired the banking operations of Washington
Mutual Bank for $1.9 billion. The fair value of the net assets acquired exceeded the purchase price
which resulted in negative goodwill. In accordance with SFAS 141, nonfinancial assets that are not
held-for-sale were written down against that negative goodwill. The negative goodwill that remained
after writing down nonfinancial assets was recognized as an extraordinary gain in 2008.
(e)
JPMorgan Chase’s common stock is listed and traded on the New York Stock Exchange, the London
Stock Exchange Limited and the Tokyo Stock Exchange. The high, low and closing prices of JPMorgan
Chase’s common stock are from The New York Stock Exchange Composite Transaction Tape.
(f)
On September 25, 2008, JPMorgan Chase acquired the banking
operations of Washington Mutual Bank. On May 30, 2008, the Bear
Stearns merger was consummated. Each of these transactions was
accounted for as a purchase and their respective results of
operations are included in the Firm’s results from each
respective transaction date. For additional information on these
transactions, see Note 2 on pages 123-128 of this Annual Report.
(g)
On July 1, 2004, Bank One Corporation merged with and
into JPMorgan Chase. Accordingly, 2004
results include six months of the combined Firm’s results and six months of heritage JPMorgan Chase
results.
The following table and graph compare the
five-year cumulative total return for JPMorgan
Chase & Co. (“JPMorgan Chase” or the “Firm”) common
stock with the cumulative return of the S&P 500
Stock Index and the S&P Financial Index. The S&P
500 Index is a commonly referenced U.S. equity
benchmark consisting of leading companies from
different economic sectors. The S&P Financial Index
is an index of 81 financial companies, all of which
are within the S&P 500. The Firm is a component of
both industry indices.
The following table and graph assumes simultaneous
investments of $100 on December 31, 2003, in
JPMorgan Chase common stock and in each of the
above S&P indices. The comparison assumes that all
dividends are reinvested.
December 31,
(in dollars)
2003
2004
2005
2006
2007
2008
JPMorgan Chase
$
100.00
$
109.92
$
116.02
$
145.36
$
134.91
$
100.54
S&P Financial Index
100.00
110.89
118.07
140.73
114.51
51.17
S&P500
100.00
110.88
116.33
134.70
142.10
89.53
This section of the JPMorgan Chase’s Annual
Report for the year ended December 31, 2008
(“Annual Report”) provides management’s discussion
and analysis of the financial condition
and results of operations (“MD&A”) of JPMorgan Chase. See
the Glossary of terms on pages 218–221 for
definitions of terms used throughout this Annual
Report. The MD&A included in this Annual Report
contains statements that are forward-looking within
the meaning of the Private Securities Litigation
Reform Act of 1995. Such statements are
based upon the current beliefs and expectations of
JPMorgan
Chase’s management and are subject to significant
risks and uncertainties. These risks and
uncertainties could cause JPMorgan Chase’s results
to differ materially from those set forth in such
forward-looking statements. Certain of such risks
and uncertainties are described herein (see
Forward-looking statements on page 115 of this
Annual Report) and in the JPMorgan Chase Annual
Report on Form 10-K for the year ended December 31,2008 (“2008 Form 10-K”), in Part I, Item 1A: Risk
factors, to which reference is hereby made.
INTRODUCTION
JPMorgan Chase & Co., a financial holding company
incorporated under Delaware law in 1968, is a
leading global financial services firm and one of
the largest banking institutions in the United
States of America (“U.S.”), with $2.2 trillion in
assets, $166.9 billion in stockholders’ equity and
operations in more than 60 countries as of December31, 2008. The Firm is a leader in investment
banking, financial services for consumers and
businesses, financial transaction processing and
asset management. Under the J.P. Morgan and Chase
brands, the Firm serves millions of customers in
the U.S. and many of the world’s most prominent
corporate, institutional and government clients.
JPMorgan Chase’s principal bank subsidiaries are
JPMorgan Chase Bank, National Association
(“JPMorgan Chase Bank, N.A.”), a national banking
association with branches in 23 states in the U.S.;
and Chase Bank USA, National Association (“Chase
Bank USA, N.A.”), a national bank that is the Firm’s
credit card issuing bank. JPMorgan Chase’s
principal nonbank subsidiary is J.P. Morgan
Securities Inc., the Firm’s U.S. investment banking
firm.
JPMorgan Chase’s activities are organized, for
management reporting purposes, into six business
segments, as well as Corporate/Private Equity. The
Firm’s wholesale businesses comprise the Investment
Bank, Commercial Banking, Treasury & Securities
Services and Asset Management segments. The Firm’s
consumer businesses comprise the Retail Financial
Services and Card Services segments.
A description
of the Firm’s business segments, and the products and
services they provide to their respective client
bases, follows.
Investment Bank
J.P. Morgan is one of the world’s leading
investment banks, with deep client relationships
and broad product capabilities. The Investment
Bank’s clients are corporations, financial
institutions, governments and
institutional investors. The Firm offers a full
range of investment banking products and services
in all major capital markets, including advising on
corporate strategy and structure, capital raising
in equity and debt markets, sophisticated risk
management, market-making in cash securities and
derivative instruments, prime brokerage and research. The Investment Bank (“IB”)
also selectively commits the Firm’s own capital to
principal investing and trading activities.
Retail Financial Services
Retail Financial Services (“RFS”), which includes
the Retail Banking and Consumer Lending reporting
segments, serves consumers and businesses through
personal service at bank branches and through ATMs,
online banking and telephone banking as well as
through auto dealerships and school financial aid
offices. Customers can use more than 5,400 bank
branches (third-largest nationally) and 14,500 ATMs
(second-largest nationally) as well as online and
mobile banking around the clock. More than 21,400
branch salespeople assist
customers with checking and savings accounts,
mortgages, home equity and business loans, and
investments across the 23-state footprint from New
York and Florida to California. Consumers also can
obtain loans through more than 16,000 auto
dealerships and 4,800 schools and universities
nationwide.
Card Services
Chase Card Services (“CS”) is one of the nation’s largest
credit card issuers with more than 168 million
cards in circulation and more than $190 billion in
managed loans. Customers used Chase cards to meet
more than $368 billion worth of their spending
needs in 2008. Chase has a market leadership
position in building loyalty and rewards programs
with many of the world’s most respected brands and
through its proprietary products, which include
the Chase Freedom program.
Through its merchant acquiring business, Chase
Paymentech Solutions, Chase is one of
the leading processors of MasterCard and Visa
payments.
Commercial Banking
Commercial Banking (“CB”) serves more than 26,000
clients nationally, including corporations,
municipalities, financial institutions and
not-for-profit entities with annual revenue
generally ranging from $10 million to $2 billion,
and nearly 30,000 real estate investors/owners.
Delivering extensive industry knowledge, local
expertise and dedicated service, CB partners with
the Firm’s other businesses to provide
comprehensive solutions, including lending,
treasury services, investment banking and asset
management to meet its clients’ domestic and
international financial needs.
Treasury & Securities Services
Treasury & Securities Services (“TSS”) is a global
leader in transaction, investment and information
services. TSS is one of the world’s largest cash
management providers and a leading global
custodian. Treasury Services (“TS”) provides cash
management, trade, wholesale card and liquidity
products and services to small and mid-sized
companies, multinational corporations, financial
institutions and government entities. TS partners
with the Commercial Banking, Retail Financial
Services and Asset Management businesses to serve
clients firmwide. As a result, certain TS revenue
is included in other segments’ results. Worldwide
Securities Services (“WSS”) holds, values, clears
and services securities, cash and alternative
investments for investors and broker-dealers, and
manages depositary receipt programs globally.
Asset Management
Asset Management (“AM”), with assets under supervision of $1.5 trillion, is a global leader in
investment and wealth management. AM clients
include institutions, retail investors and
high-net-worth individuals in every major market
throughout the world. AM offers global investment
management in equities, fixed income, real estate,
hedge funds, private equity and liquidity,
including money market instruments and bank
deposits. AM also provides trust and estate,
banking and brokerage services to high-net-worth
clients, and retirement services for corporations
and individuals. The majority of AM’s client assets
are in actively managed portfolios.
This overview of management’s discussion and
analysis highlights selected information and may
not contain all of the information that is
important to readers of this Annual Report. For a
complete description of events, trends and
uncertainties, as well as the capital, liquidity,
credit and market risks, and the critical
accounting estimates affecting the Firm and its
various lines of business, this Annual Report
should be read in its entirety.
Financial performance of JPMorgan Chase
Year ended December 31,
(in millions, except per share and ratio data)
2008
(c)
2007
Change
Selected income statement data
Total net revenue
$
67,252
$
71,372
(6
)%
Provision for credit losses(a)
20,979
6,864
206
Total noninterest expense
43,500
41,703
4
Income before extraordinary gain
3,699
15,365
(76
)
Extraordinary gain(b)
1,906
—
NM
Net income
5,605
15,365
(64
)
Diluted earnings per share
Income before extraordinary gain
$
0.84
$
4.38
(81
)
Net income
1.37
4.38
(69
)
Return on common equity
Income before extraordinary gain
2
%
13
%
Net income
4
%
13
%
(a)
Includes an accounting conformity provision
for credit losses of $1.5 billion related to the
acquisition of Washington Mutual’s banking
operations in 2008.
(b)
JPMorgan Chase acquired the banking operations of
Washington Mutual Bank from the Federal Deposit
Insurance Corporation (“FDIC”) for $1.9 billion. The
fair value of the net assets acquired from the FDIC
exceeded the purchase price which resulted in
negative goodwill. In accordance with SFAS 141,
nonfinancial assets that are not held-for-sale were
written down against that negative goodwill. The
negative goodwill that remained after writing down
nonfinancial assets was recognized as an
extraordinary gain in 2008.
The allocation of the purchase price to the net
assets acquired (based on their respective fair
values at September 25, 2008) and the resulting
negative goodwill may be modified through September25, 2009, as more information is obtained about the
fair value of assets acquired and liabilities
assumed.
(c)
On September 25, 2008, JPMorgan Chase acquired the
banking operations of Washington Mutual Bank. On May 30, 2008,
the Bear Stearns merger was consummated. Each of these transactions
was accounted for as a purchase and their respective results of
operations are included in the Firm’s results from each
respective transaction date. For additional information on these
transactions, see Note 2 on pages 123-128 of this Annual Report.
Business overview
JPMorgan Chase reported 2008 net income of $5.6
billion, or $1.37 per share, and total net revenue
of $67.3 billion, compared with record net income
of $15.4 billion, or $4.38 per share, and record
total net revenue of $71.4 billion, for 2007. Return
on common equity was 4% in 2008, compared with 13%
in 2007. Results in 2008
include the acquisition of The Bear Stearns Companies Inc. (“Bear
Stearns”) on May 30,2008, and the acquisition of the banking operations of Washington Mutual
Bank (“Washington Mutual”) on September 25, 2008.
The decline in net income for the year was the
result of a significantly higher provision for
credit losses, reflecting the addition of $13.7
billion to the Firm’s allowance for credit losses in
2008; a decline in total net revenue driven by over
$10 billion of markdowns on mortgage-related
positions and leveraged lending exposures in the
Investment Bank; and an increase in total
noninterest expense due
to the impact of the Washington Mutual
transaction and the Bear Stearns merger.
The business environment for financial services
firms was extremely challenging in 2008. The global
economy slowed, with many countries, including the
U.S., slipping into recession. Financial conditions
worsened throughout the year amid a number of
unprecedented developments that undermined the
economic outlook and eroded confidence in global
financial markets. JPMorgan Chase acquired Bear
Stearns through a merger consummated
in May and acquired the banking operations of
Washington Mutual from the Federal Deposit
Insurance Corporation (“FDIC”) in September. The
U.S. federal government placed the Federal Home
Loan Mortgage Corporation (“Freddie Mac”) and the
Federal National Mortgage Association (“Fannie
Mae”) under its control. Lehman Brothers Holdings
Inc. declared bankruptcy. The Bank of America
Corporation acquired Merrill Lynch & Co., Inc. and
Wells Fargo & Company acquired Wachovia
Corporation. The government provided a loan to
American International Group, Inc. (“AIG”) in
exchange for an equity interest in AIG to prevent
the insurer’s failure. Morgan Stanley, The Goldman
Sachs Group, Inc., GMAC, American Express, Discover
Financial Services and CIT Group received approval
from the Board of Governors of the Federal Reserve
System (the “Federal Reserve”) to become federal
bank holding companies. In other industries,
the U.S. government provided temporary loans to General
Motors Corporation and Chrysler LLC.
These events accompanied severe strains in term
funding markets, reflecting heightened concerns
about counterparty risk. As a result, LIBOR rates
rose significantly in the fall, despite a round of
coordinated rate cuts by a number of central banks.
By year-end, LIBOR rates eased in response to
proposals to insure deposits and selected debt of
financial institutions. The turmoil in financial
markets during 2008 led to tighter credit
conditions and diminished liquidity, causing
consumers and businesses around the world to become
more cautious and curtail spending and investment
activity. As a result, the U.S. economy contracted
sharply, 2.8 million jobs were lost in 2008, and
the U.S. unemployment rate rose significantly, to
7.2% by year-end.
The continued economic and financial disruption led
the Federal Reserve to reduce its target overnight
interest rates to near zero in the fourth quarter
of 2008, capping off a year of near-continuous rate
reductions. In addition, the U.S. Department of the
Treasury (the “U.S. Treasury”), the Federal Reserve
and the FDIC, working in cooperation with foreign
governments and other central banks, including the
Bank of England, the European Central Bank and the
Swiss National Bank, began, in the fourth quarter
of 2008, to take a variety of extraordinary
measures designed to restore confidence in the
financial markets and strengthen financial
institutions, including capital injections,
guarantees of bank liabilities and the acquisition
of illiquid assets from banks. In particular, on
October 3, 2008, the Emergency Economic
Stabilization Act of 2008 (the “EESA”) was signed
into law. Pursuant to the EESA, the U.S. Treasury
has the authority to take a range of
actions to stabilize and provide liquidity to
the U.S. financial markets, including the purchase
by the U.S. Treasury of certain troubled assets
from financial institutions (the “Troubled Asset
Relief Program”) and the direct purchase by the
U.S. Treasury of equity of financial institutions
(the “Capital Purchase Program”).
The efforts to restore confidence in the financial
markets and promote economic growth continue in
2009, with initiatives including a fiscal stimulus
bill, the American Reinvestment and Recovery Act of
2009, which was signed into law by President Barack
Obama on February 17, 2009. Also in February,
the U.S. Treasury outlined a
plan to restore stability to the
financial system and President Obama proposed a
plan to help distressed homeowners. The Federal Reserve, working
with other government and regulatory agencies, has
also implemented a number of new programs to
promote the proper functioning of the credit
markets and reintroduce liquidity to the financial
system. Such
actions taken by U.S. regulatory agencies include
the introduction of programs to restore liquidity
to money market mutual funds, the commercial paper
market, and other fixed-income securities markets.
In addition, the FDIC issued a temporary liquidity guarantee
program (the “TLG Program”) for the senior debt of all FDIC-insured
institutions, as well as deposits in
noninterest-bearing transaction deposit accounts.
Despite the difficult operating environment and
overall drop in earnings, JPMorgan Chase maintained
a strong balance sheet and produced underlying
growth in many business areas. The Tier 1 capital
ratio was 10.9% at year-end; Treasury & Securities
Services and
Commercial Banking each reported record revenue and
net income for the second straight year; the
consumer businesses opened millions of new checking
and credit card accounts; Asset Management
experienced record net inflows in assets under
management; and the Investment Bank gained market
share in all major fee categories. The diversified
nature of the Firm’s businesses and its strong
capital position enabled it to weather the
recessionary environment during 2008.
JPMorgan Chase has taken a leadership role in
helping to stabilize the financial markets. It
assumed the risk and expended the necessary
resources to acquire Bear Stearns and the banking
operations of Washington Mutual. In October 2008,
the Firm agreed to accept a $25 billion capital
investment by the U.S. Treasury under the Capital Purchase Program.
JPMorgan Chase has continued to lend to clients in a safe and sound
manner and to provide liquidity to multiple
financial markets. The Firm has implemented
programs that have prevented more than 300,000
foreclosures, with plans to help more than 400,000
more families keep their homes through Chase-owned
mortgage modifications over the next two years. The
Firm has expanded this effort to include over $1.1
trillion of investor-owned mortgages.
The discussion that follows highlights the
performance of each business segment compared with
the prior year, and discusses results on a managed
basis unless otherwise noted. For more information
about managed basis, see Explanation and
reconciliation of the Firm’s use of non-GAAP
financial measures on pages 38–39 of this Annual
Report.
Investment Bank reported a net loss for the year,
compared with net income in 2007. The significant
decline in results reflected lower total net
revenue, a higher provision for credit losses and
higher total noninterest expense. Markdowns of over
$10 billion on mortgage-related positions and
leveraged lending funded and unfunded commitments
drove fixed income trading revenue lower;
investment banking fees and equity trading revenue
declined as well. These decreases were offset by
record performance in rates and currencies, credit
trading, commodities and emerging markets, as well
as strong equity client revenue, and gains from the
widening of the Firm’s credit spread on certain
structured liabilities and derivatives. The
provision for credit losses rose from the 2007
level, predominantly reflecting a higher allowance
for credit losses, driven by a weakening credit
environment, as well as the effect of the transfer
of $4.9 billion of funded and unfunded leveraged
lending commitments to retained loans from
held-for-sale in the first quarter of 2008. The
increase in total noninterest expense was largely
driven by additional expense relating to the Bear
Stearns merger, offset partially by lower
performance-based compensation expense. In
addition, IB benefited from a reduction in deferred
tax liabilities on overseas earnings.
Retail Financial Services net income declined,
reflecting a significant increase in the provision
for credit losses, predominantly offset by positive
mortgage servicing rights (“MSR”) risk management
results and the positive impact of the Washington
Mutual transaction. Additional drivers of revenue
growth included wider loan and deposit spreads and
higher loan and deposit balances. The provision for
credit losses increased as housing price declines
have continued to result in significant increases
in estimated losses, particularly for high
loan-to-value home equity and mortgage loans. The
provision was also affected by an increase in
estimated losses for the auto, student and business
banking loan portfolios. Total noninterest expense
rose from the 2007 level, reflecting the impact of
the Washington Mutual transaction, higher mortgage
reinsurance losses, increased mortgage servicing
expense and investments in the retail distribution
network.
Card Services net income declined, driven by a
higher provision for credit losses partially offset
by higher managed total net revenue. The growth in
managed total net revenue was driven by the impact
of the Washington Mutual transaction, higher
average managed loan balances, wider loan spreads
and increased interchange income, off-set
predominantly by increased rewards expense and
higher volume-driven payments to partners, as well
as the effect of higher revenue reversals
associated with higher charge-offs. The managed
provision for credit losses increased from the
prior year due to an increase in the allowance for
loan losses and a higher level of charge-offs.
Total noninterest expense rose from last year,
largely due to the impact of the Washington Mutual
transaction.
Commercial Banking net income increased, surpassing
the record level posted in 2007. The results were
driven by record total net revenue, partially
offset by an increase in the provision for credit
losses. The increase in revenue was driven by
double-digit growth in liability and loan balances,
the impact of the Washington Mutual transaction,
higher deposit and lending-related fees, and
increases in other fee
income. These were partially offset by spread
compression in the liability and loan portfolios.
The increase in the provision for credit losses
reflected a weakening credit environment and growth
in loan balances. Total noninterest expense
decreased from the prior year, due to lower
performance-based incentive compensation and
volume-based charges from service providers,
predominantly offset by the impact of the
Washington Mutual transaction.
Treasury & Securities Services net income increased
over the record level set in 2007, driven by record
total net revenue, partially offset by higher
noninterest expense. Worldwide Securities Services
posted record net revenue, driven by wider spreads
in securities lending, foreign exchange and
liability products, increased
product usage by new and existing clients, and
higher liability balances. These benefits were
partially offset by market depreciation. Treasury
Services posted record net revenue, reflecting
higher liability balances and volume growth in
electronic funds transfer products and trade loans.
Total noninterest expense increased, reflecting
higher expense related to business and volume
growth, as well as continued investment in new
product platforms.
Asset Management net income decreased, driven by
lower total net revenue, offset partially by lower
total noninterest expense. The decline in revenue
was due to lower performance fees and the effect of
lower markets, including the impact of lower market
valuations of seed capital investments. Partially
offsetting these revenue declines were higher
deposit and loan balances, the benefit of the Bear
Stearns merger, increased revenue from net asset
inflows and wider deposit spreads. The provision
for credit losses rose from the prior year,
reflecting an increase in loan balances, higher net
charge-offs and a weakening credit environment.
Total noninterest expense declined compared with
2007, driven by lower performance-based
compensation, largely offset by the effect of the
Bear Stearns merger and higher compensation expense
resulting from increased average headcount.
Corporate/Private Equity net income declined from
the 2007 level and included an extraordinary gain
related to the Washington Mutual transaction and a
conforming loan loss provision. Excluding these
items, the decrease in net income from the prior
year was driven by private equity losses in 2008,
compared with gains in 2007, losses on preferred
securities of Fannie Mae and Freddie Mac, and a
charge related to the offer to repurchase
auction-rate securities. These declines were
partially offset by the proceeds from the sale of
Visa shares in its initial public offering and a
gain on the dissolution of the Chase Paymentech
Solutions joint venture and the gain from the sale
of MasterCard shares. The decrease in total
noninterest expense reflected a reduction of credit
card-related litigation expense, partially offset
by higher merger costs.
The Firm’s managed provision for credit losses was
$24.6 billion for 2008, compared with $9.2 billion
for 2007. The total consumer-managed provision for
credit losses was $21.3 billion, compared with $8.3
billion in the prior year, reflecting increases in
the allowance for credit losses related to home
equity, mortgage and credit card loans, as well as
higher net charge-offs. Consumer-managed net
charge-offs were $13.0 billion, compared with $6.8
billion in the prior year,
resulting in managed net charge-off rates of 3.06%
and 1.97%, respectively. The wholesale provision
for credit losses was $3.3 billion, compared with
$934 million in the prior year, due to an increase
in the allowance for credit losses reflecting the
effect of a weakening credit environment and loan
growth. Wholesale net charge-offs were $402
million, compared with net charge-offs of $72
million in the prior year, resulting in net
charge-off rates
of 0.18% and 0.04%, respectively. The Firm had
total nonperforming assets of $12.7 billion at
December 31, 2008, up from the prior-year level of
$3.9 billion.
Total stockholders’ equity at December 31, 2008,
was $166.9 billion, and the Tier 1 capital ratio
was 10.9%. During 2008, the Firm raised $11.5
billion of common equity and $32.8 billion of
preferred equity, including a warrant issued to the
U.S. Treasury.
2009 Business outlook The following forward-looking statements are
based upon the current beliefs and expectations of
JPMorgan Chase’s management and are subject to
significant risks and uncertainties. These risks
and uncertainties could cause JPMorgan Chase’s
actual results to differ materially from those set
forth in such forward-looking statements.
JPMorgan
Chase’s outlook for 2009 should be viewed against the backdrop
of the global and U.S. economies, financial markets activity,
the geopolitical environment, the competitive environment and client
activity levels. Each of these linked factors will affect the
performance of the Firm and its lines of business. In addition, as a
result of recent market conditions and events, Congress and
regulators have increased their focus on the regulation of financial
institutions. The Firm’s current expectations are for the global
and U.S. economic environments to weaken further and potentially
faster, capital markets to remain under stress, for there to be a
continued decline in U.S. housing prices, and for Congress and
regulators to continue to adopt legislation and regulations that
could limit or restrict the Firm’s operations, or impose
additional costs upon the Firm in order to comply with such new laws
or rules. These factors are likely to continue to adversely impact
the Firm’s revenue, credit costs, overall business volumes and
earnings.
Given the potential
stress on the consumer from rising unemployment,
the continued downward pressure on housing prices
and the elevated national inventory of unsold
homes, management remains extremely cautious with
respect to the credit outlook for home equity,
mortgage and credit card portfolios. Management expects continued deterioration
in credit trends for the home equity, mortgage and credit card portfolios, which
will likely require additions to the consumer loan
loss allowance in 2009 or beyond. Economic data released in early 2009 indicated
that housing prices and the labor market have weakened further since
year-end, and that deterioration could continue into late 2009.
Based on management’s current economic outlook,
quarterly net charge-offs could, over the next several
quarters, reach $1.0 billion to $1.4 billion for the home equity
portfolio, $375 million to $475 million for the prime mortgage
portfolio, and $375 million to $475 million for the
subprime mortgage portfolio. Management expects the
managed net charge-off rate for Card Services
(excluding the impact resulting from the
acquisition of Washington Mutual’s banking
operations) to approach 7% in the first quarter of
2009 and likely higher by the end of
the year depending on unemployment levels. These charge-off rates could increase
even further if the economic environment continues
to deteriorate
further than management’s current
expectations. The wholesale provision for credit
losses and nonperforming assets are likely to
increase over time as a result of the
deterioration in underlying credit conditions.
Wholesale net charge-offs in 2008 increased from
historic lows in 2007 and are likely to increase
materially in 2009 as a result of increasing
weakness in the credit environment.
The Investment Bank continues to be negatively
affected by the disruption in the credit and
mortgage markets, as well as by overall lower
levels of liquidity. The continuation of these
factors could potentially lead to reduced levels of
client activity, lower investment banking fees and
lower trading revenue. In addition, if the Firm’s
own credit spreads tighten, as they did in the
fourth quarter of 2008, the change in the fair
value of certain trading liabilities would also
negatively affect trading results. The Firm held
$12.6 billion (gross notional) of legacy leveraged
loans and unfunded commitments as held-for-sale as
of December 31, 2008. Markdowns averaging 45% of
the gross notional value have been taken on these
legacy positions as of December 31, 2008, resulting
in a net carrying value of $6.9 billion. Leveraged
loans and unfunded commitments are difficult to
hedge effectively, and if market conditions further
deteriorate, additional markdowns may be necessary
on this asset class. The Investment Bank also held,
at December 31, 2008, an aggregate $6.1 billion of
prime and Alt-A mortgage exposure, which is also
difficult to hedge effectively, and $875 million of
subprime mortgage exposure. In addition, the
Investment Bank had $7.7 billion of commercial
mortgage exposure. In spite of active hedging,
mortgage exposures could be adversely affected by
worsening market conditions and further deterioration
in the housing market. The combination of credit
costs and additional markdowns on the various exposures noted above
could reach or exceed $2.0 billion for the first quarter of 2009.
Earnings in Commercial Banking and Treasury &
Securities Services could decline due to the impact of tighter
spreads in the low interest rate environment or a decline in the level of liability balances. Earnings in
Treasury & Securities Services and Asset Management
will likely deteriorate if market levels continue
to decline, due to reduced levels of assets under
management, supervision and custody. Earnings in the Corporate/Private
Equity segment could be more volatile due to
increases in the size of the Firm’s investment
portfolio, which is largely comprised of
investment-grade securities. Private Equity results
are dependent upon the capital markets and at
current market levels, management believes
additional write-downs of $400 million or more are likely in the
first quarter of 2009.
Assuming
economic conditions do not worsen beyond management’s current
expectations, management continues to believe that the net income
impact of the acquisition of Washington Mutual’s
banking operations could be approximately $0.50 per
share in 2009; the Bear Stearns merger could contribute $1
billion (after-tax) annualized after 2009; and merger-related items, which include both the
Washington Mutual transaction and the Bear Stearns
merger, could be approximately $600 million
(after-tax) in 2009.
Recent
Developments
On
February 23, 2009, the Board of Directors reduced the
Firm’s quarterly common stock dividend from $0.38 to $0.05 per
share, effective for the dividend payable April 30, 2009 to
shareholders of record on April 6, 2009. The action will enable
the Firm to retain an additional $5.0 billion in common equity per
year. The Firm expects to maintain the dividend at this level for the
time being. The action was taken in order to help ensure that the
Firm’s balance sheet retained the capital strength necessary to
weather a further decline in economic conditions. The Firm intends to
return to a more normalized dividend payout as soon as feasible after
the environment has stabilized.
The following section provides a comparative
discussion of JPMorgan Chase’s Consolidated Results
of Operations on a reported basis for the three-year
period ended December 31, 2008. Factors that related
primarily to a single business segment are discussed
in more detail within that business segment. For a
discussion of the Critical Accounting Estimates Used
by the Firm that affect the Consolidated Results of
Operations, see pages 107–111 of this Annual
Report.
Revenue
Year ended December 31, (in millions)
2008
(a)
2007
2006
Investment banking fees
$
5,526
$
6,635
$
5,520
Principal transactions
(10,699
)
9,015
10,778
Lending & deposit-related fees
5,088
3,938
3,468
Asset
management, administration and
commissions
13,943
14,356
11,855
Securities gains (losses)
1,560
164
(543
)
Mortgage fees and related income
3,467
2,118
591
Credit card income
7,419
6,911
6,913
Other income
2,169
1,829
2,175
Noninterest revenue
28,473
44,966
40,757
Net interest income
38,779
26,406
21,242
Total net revenue
$
67,252
$
71,372
$
61,999
(a)
On September 25, 2008, JPMorgan Chase acquired the banking
operations of Washington Mutual Bank. On May 30, 2008, the Bear
Stearns merger was consummated. Each of these transactions was
accounted for as a purchase and their respective results of
operations are included in the Firm’s results from each
respective transaction date. For additional information on these
transactions, see Note 2 on pages 123-128 of this Annual Report.
2008 compared with 2007
Total net revenue of $67.3 billion was down $4.1
billion, or 6%, from the prior year. The decline
resulted from the extremely challenging business
environment for financial services firms in 2008.
Principal transactions revenue decreased
significantly and included net markdowns on
mortgage-related positions and leveraged lending
funded and unfunded commitments, losses on
preferred securities of Fannie Mae and Freddie Mac,
and losses on private equity investments. Also
contributing to the decline in total net revenue
were other losses and markdowns recorded in other
income, including the
Firm’s share of Bear Stearns’ losses from April 8
to May 30, 2008. These declines were largely offset
by higher net interest income, proceeds from the
sale of Visa shares in its initial public offering,
and the gain on the dissolution of the Chase
Paymentech Solutions joint venture.
Investment banking fees were down from the record
level of the prior year due to lower debt
underwriting fees, as well as lower advisory and
equity underwriting fees, both of which were at
record levels in 2007. These declines were
attributable to reduced market activity. For a
further discussion of investment banking fees,
which are primarily recorded in IB, see IB segment
results on pages 42–44 of this Annual Report.
In 2008, principal transactions revenue, which
consists of revenue from the Firm’s trading and
private equity investing activities, declined by
$19.7 billion from the prior year. Trading revenue
decreased $14.5 billion to a negative $9.8 billion
compared with a positive $4.7 billion in 2007. The
decline in trading revenue was largely driven by
higher net markdowns of $5.9 billion on mortgage-
related exposures compared with $1.4 billion in the
prior year; higher net markdowns of $4.7 billion on
leveraged lending funded and unfunded commitments
compared with $1.3 billion in the prior year;
losses of $1.1 billion on preferred securities of
Fannie Mae and Freddie Mac; and weaker equity
trading results compared with a record level in
2007. In addition, trading revenue was adversely
impacted by the Bear Stearns merger. Partially
offsetting the decline in trading revenue were
record results in rates and currencies, credit
trading, commodities and emerging markets, as well
as strong equity client revenue across products and
total gains of $2.0 billion from the widening of
the Firm’s credit spread on certain structured
liabilities and derivatives, compared with $1.3
billion in 2007. Private equity results also
declined substantially from the prior year,
swinging to losses of $908 million in 2008 from
gains of $4.3 billion in 2007. In addition, the
first quarter of 2007 included a fair value
adjustment related to the adoption of SFAS 157. For
a further discussion of principal transactions
revenue, see IB and Corporate/Private Equity
segment results on pages 42–44 and 61–63,
respectively, and Note 6 on pages 146–148 of this
Annual Report.
Lending & deposit-related fees rose from the prior
year, predominantly resulting from higher
deposit-related fees and the impact of the
Washington Mutual transaction. For a further
discussion of lending & deposit-related fees, which
are mostly recorded in RFS, TSS and CB, see the RFS
segment results on pages 45–50, the TSS segment
results on pages 56–57, and the CB segment results
on pages 54–55 of this Annual Report.
The decline in asset management, administration and
commissions revenue compared with 2007 was driven
by lower asset management fees in AM due to lower
performance fees and the effect of lower markets on
assets under management. This decline was partially
offset by an increase in commissions revenue related
predominantly to higher brokerage transaction
volume within IB’s equity markets revenue, which
included additions from Bear Stearns’ Prime
Services business; and higher administration fees
in TSS driven by wider spreads in securities
lending and increased product usage by new and
existing clients. For additional information on
these fees and commissions, see the segment
discussions for IB on pages 42–44, RFS on pages
45–50, TSS on pages 56–57, and AM on pages 58–60
of this Annual Report.
The increase in securities gains compared with the
prior year was due to the repositioning of the
Corporate investment securities portfolio as a
result of lower interest rates as part of managing
the structural interest rate risk of the Firm, and
higher gains from the sale of MasterCard shares.
For a further discussion of securities gains, which
are mostly recorded in the Firm’s Corporate
business, see the Corporate/Private Equity segment
discussion on pages 61–63 of this Annual Report.
Mortgage fees and related income increased from the
prior year, driven by higher net mortgage servicing
revenue, which benefited from an improvement in MSR
risk management results and increased loan
servicing revenue. Mortgage production revenue
increased slightly, as the impact of growth in
originations was predominantly
offset by markdowns on the mortgage warehouse
and increased reserves related to the repurchase of
previously sold loans. For a discussion of mortgage
fees and related income, which is recorded
primarily in RFS’ Consumer Lending business, see
the Consumer Lending discussion on pages 47–50 of
this Annual Report.
Credit card income rose compared with the prior
year, driven by increased interchange income due to
higher customer charge volume in CS and higher
debit card transaction volume in RFS, the impact of
the Washington Mutual transaction, and increased
servicing fees resulting from a higher level of
securitized receivables. These results were
partially offset by increases in volume-driven
payments to partners and expense related to rewards
programs. For a further discussion of credit card
income, see CS’ segment results on pages 51–53 of
this Annual Report.
Other income increased compared with the prior
year, due predominantly to the proceeds from the
sale of Visa shares in its initial public offering
of $1.5 billion, the gain on the dissolution of the
Chase Paymentech Solutions joint venture of $1.0
billion, and gains on sales of certain other
assets. These proceeds and gains were partially
offset by markdowns on certain investments,
including seed capital in AM; a $464 million charge
related to the offer to repurchase auction-rate
securities at par; losses of $423 million
reflecting the Firm’s 49.4% ownership in Bear
Stearns’ losses from
April 8 to May 30, 2008; and lower securitization
income at CS.
Net interest income rose from the prior year, due
predominantly to the following: higher
trading-related net interest income in IB, the
impact of the Washington Mutual transaction, wider
net interest spread in Corporate/Private Equity,
growth in liability and deposit balances in the
wholesale and RFS businesses, higher consumer and
wholesale loan balances, and wider spreads on
consumer loans in RFS. The Firm’s total average
interest-earning assets for 2008 were $1.4
trillion, up 23% from the prior year, driven by
higher loans, AFS securities, securities borrowed,
brokerage receivables and other interest-earning
assets balances. The Firm’s total average
interest-bearing liabilities for 2008 were $1.3
trillion, up 24% from the prior year, driven by
higher deposits, long-term debt, brokerage payables
and other borrowings balances. The net interest
yield on the Firm’s interest-earning assets, on a
fully taxable equivalent basis, was 2.87%, an
increase of 48 basis points from the prior year.
2007 compared with 2006
Total net revenue of $71.4 billion was up $9.4
billion, or 15%, from the prior year. Higher net
interest income, very strong private equity gains,
record asset management, administration and
commissions revenue, higher mortgage fees and
related income, and record investment banking fees
contributed to the revenue growth. These increases
were offset partially by lower trading revenue.
Investment banking fees grew in 2007 to a level
higher than the previous record set in 2006. Record
advisory and equity underwriting fees drove the
results, partially offset by lower debt
underwriting fees. For a further discussion of
investment banking fees, which are primarily
recorded in IB, see IB segment results on pages
42–44 of this Annual Report.
Principal transactions revenue consists of trading
revenue and private equity gains. Trading revenue
declined significantly from the 2006 level,
primarily due to net markdowns in IB of $1.4
billion on sub-prime positions, including subprime
collateralized debt obligations (“CDOs”), and $1.3
billion on leveraged lending funded loans and
unfunded commitments. Also in IB, markdowns of
securitized products related to nonsubprime
mortgages and weak credit trading performance more
than offset record revenue in currencies and strong
revenue in both rates and equities. Equities
benefited from strong client activity and record
trading results across all products. IB’s Credit
Portfolio results increased compared with the prior
year, primarily driven by higher revenue from risk
management activities. The increase in private
equity gains from 2006 reflected a significantly
higher level of gains, the classification of
certain private equity carried interest as
compensation expense and a fair value adjustment in
the first quarter of 2007 on nonpublic private
equity investments resulting from the adoption of
SFAS 157 (“Fair Value Measurements”). For a further
discussion of principal transactions revenue, see
IB and Corporate/Private Equity segment results on
pages 42–44 and 61–63, respectively, and Note 6
on pages 146–148 of this Annual Report.
Lending & deposit-related fees rose from the 2006
level, driven primarily by higher deposit-related
fees and the Bank of New York transaction. For a
further discussion of lending & deposit-related
fees, which are mostly recorded in RFS, TSS and CB,
see the RFS segment results on pages 45–50, the
TSS segment results on pages 56–57, and the CB
segment results on pages 54–55 of this Annual
Report.
Asset management, administration and commissions
revenue reached a level higher than the previous
record set in 2006. Increased assets under
management and higher performance and placement
fees in AM drove the record results. The 18% growth
in assets under management from year-end 2006 came
from net asset inflows and market appreciation
across all segments: Institutional, Retail, Private
Bank and Private Wealth Management. TSS also
contributed to the rise in asset management,
administration and commissions revenue, driven by
increased product usage by new and existing clients
and market appreciation on assets under custody.
Finally, commissions revenue increased, due mainly
to higher brokerage transaction volume (primarily
included within Fixed Income and Equity Markets
revenue of IB), which more than offset the sale of
the insurance business by RFS in the third quarter
of 2006 and a charge in the first quarter of 2007
resulting from accelerated surrenders of customer
annuities. For additional information on these fees
and commissions, see the segment discussions for IB
on pages 42–44, RFS on pages 45–50, TSS on pages
56–57, and AM on pages 58–60 of this Annual
Report.
The favorable variance resulting from securities
gains in 2007 compared with securities losses in
2006 was primarily driven by improvements in the
results of repositioning of the Corporate
investment securities portfolio. Also contributing
to the positive variance was a $234 million gain
from the sale of MasterCard shares. For a further
discussion of securities gains (losses), which are
mostly recorded in the Firm’s Corporate business,
see the Corporate/Private Equity segment discussion
on pages 61–63 of this Annual Report.
Mortgage fees and related income increased from
the prior year as MSRs asset valuation adjustments
and growth in third-party mortgage loans serviced
drove an increase in net mortgage servicing
revenue. Production revenue also grew, as an
increase in mortgage loan originations and the
classification of certain loan origination costs as
expense (loan origination costs previously netted
against revenue commenced being recorded as an
expense in the first quarter of 2007 due to the
adoption of SFAS 159) more than offset markdowns on
the mortgage warehouse and pipeline. For a
discussion of mortgage fees and related
income, which is recorded primarily in RFS’
Consumer Lending business, see the Consumer Lending
discussion on pages 47–50 of this Annual Report.
Credit card income remained relatively unchanged
from the 2006 level, as lower servicing fees earned
in connection with securitization activities, which
were affected unfavorably by higher net credit
losses and narrower loan margins, were offset by
increases in net interchange income earned on the
Firm’s credit and debit cards. For further
discussion of credit card income, see CS’ segment
results on pages 51–53 of this Annual Report.
Other income declined compared with the prior
year, driven by lower gains from loan sales and
workouts, and the absence of a $103 million gain in
the second quarter of 2006 related to the sale of
MasterCard shares in its initial public
offering. (The 2007 gain on the sale of MasterCard
shares was recorded in securities gains (losses) as
the shares were transferred to the AFS portfolio
subsequent to the IPO.) Increased income from
automobile operating leases and higher gains on the
sale of leveraged leases and student loans
partially offset the decline.
Net interest income rose from the prior
year, primarily due to the following: higher
trading-related net interest income, due to a shift
of Interest expense to principal transactions
revenue (related to certain IB structured notes to
which fair value accounting was elected in
connection with the adoption of SFAS 159); growth in
liability and deposit balances in the wholesale and
consumer businesses; a higher level of credit card
loans; the impact of the Bank of New York
transaction; and an improvement in Corporate’s net
interest spread. The Firm’s total average
interest-earning assets for 2007 were $1.1
trillion, up 12% from the prior year. The increase
was primarily driven by higher trading assets –
debt instruments, loans, and AFS
securities, partially offset by a decline in
interests in purchased receivables as a result of
the restructuring and deconsolidation during the
second quarter of 2006 of certain multi-seller
conduits that the Firm administered. The net
interest yield on these assets, on a fully taxable
equivalent basis, was 2.39%, an increase of 23 basis
points from the prior year, due in part to the
adoption of SFAS 159.
Provision for credit losses
Year ended December 31,
(in millions)
2008(b)
2007
2006
Wholesale:
Provision for credit losses
$
2,681
$
934
$
321
Provision
for credit losses – accounting conformity(a)
646
—
—
Total wholesale provision for
credit losses
3,327
934
321
Consumer:
Provision for credit losses
16,764
5,930
2,949
Provision for credit losses –
accounting conformity(a)
888
—
—
Total consumer provision for
credit losses
17,652
5,930
2,949
Total provision for credit losses
$
20,979
$
6,864
$
3,270
(a)
2008 included adjustments to the
provision for credit losses to conform the
Washington Mutual loan loss reserve methodologies
to the Firm’s methodologies in connection with
the Washington Mutual transaction.
(b)
On September 25, 2008, JPMorgan Chase acquired the banking
operations of Washington Mutual Bank. On May 30, 2008, the Bear
Stearns merger was consummated. Each of these transactions was
accounted for as a purchase and their respective results of
operations are included in the Firm’s results from each
respective transaction date. For additional information on these
transactions, see Note 2 on pages 123-128 of this Annual Report.
2008 compared with 2007
The provision for credit losses in 2008 rose by
$14.1 billion compared with the prior year due to
increases in both the consumer and wholesale
provisions. The increase in the consumer provision
reflected higher estimated losses for home equity
and mortgages resulting from declining housing
prices; an increase in estimated losses for the
auto, student and business banking loan
portfolios; and an increase in the allowance for
loan losses and higher charge-offs of credit card
loans. The increase in the wholesale provision was
driven by a higher allowance resulting from a
weakening credit environment and growth in retained
loans. The wholesale provision in the first quarter
of 2008 also included the effect of the transfer of
$4.9 billion of funded and unfunded leveraged
lending commitments to retained loans from
held-for-sale. In addition, in 2008 both the consumer
and wholesale provisions were affected by a $1.5
billion charge to conform assets acquired from
Washington Mutual to the Firm’s loan loss
methodologies. For a more detailed discussion of the
loan portfolio and the allowance for loan
losses, see the segment discussions for RFS on pages
45–50, CS on pages 51–53, IB on pages 42–44 and
CB on pages 54–55, and the Credit Risk Management
section on pages 80–99 of this Annual Report.
2007 compared with 2006
The provision for credit losses in 2007 rose $3.6
billion from the prior year due to increases in
both the consumer and wholesale provisions. The
increase in the consumer provision from the prior
year was largely due
to an increase in estimated losses related to home
equity, credit card and subprime mortgage
loans. Credit card net charge-offs in 2006 benefited
following the change in bankruptcy legislation in
the fourth quarter of 2005. The increase in the
wholesale provision from the prior year primarily
reflected an increase in the allowance for
credit losses due to portfolio activity, which
included the effect of a weakening credit
environment and portfolio growth. For a more
detailed discussion of the loan portfolio and the
allowance for loan losses, see the segment
discussions for RFS on pages 45–50, CS on pages
51–53, IB on pages 42–44, CB on pages 54–55 and
Credit Risk Management on pages 80–99 of this
Annual Report.
Noninterest expense
Year ended December 31,
(in millions)
2008(a)
2007
2006
Compensation expense
$
22,746
$
22,689
$
21,191
Noncompensation expense:
Occupancy expense
3,038
2,608
2,335
Technology, communications
and equipment expense
4,315
3,779
3,653
Professional & outside services
6,053
5,140
4,450
Marketing
1,913
2,070
2,209
Other expense
3,740
3,814
3,272
Amortization of intangibles
1,263
1,394
1,428
Total
noncompensation expense
20,322
18,805
17,347
Merger costs
432
209
305
Total noninterest expense
$
43,500
$
41,703
$
38,843
(a)
On September 25, 2008, JPMorgan Chase acquired the banking
operations of Washington Mutual Bank. On May 30, 2008, the Bear
Stearns merger was consummated. Each of these transactions was
accounted for as a purchase and their respective results of
operations are included in the Firm’s results from each
respective transaction date. For additional information on these
transactions, see Note 2 on pages 123-128 of this Annual Report.
2008 compared with 2007
Total noninterest expense for 2008 was $43.5
billion, up $1.8 billion, or 4%, from the prior
year. The increase was driven by the additional
operating costs related to the Washington Mutual
transaction and Bear Stearns merger, and investments
in the businesses, partially offset by lower
performance-based incentives.
Compensation expense increased slightly from the
prior year predominantly driven by investments in
the businesses, including headcount additions
associated with the Bear Stearns merger and
Washington Mutual transaction, largely offset by
lower performance-based incentives.
Noncompensation expense increased from the prior
year as a result of the Bear Stearns merger and
Washington Mutual transaction. Excluding the effect
of these transactions, noncompensation expense
decreased due to a net reduction in other expense
related to litigation; lower credit card and
consumer lending marketing expense; and a decrease
in the amortization of intangibles as certain
purchased credit card relationships were fully
amortized in 2007 and the amortization rate for
core deposit intangibles declined in accordance
with the amortization schedule. These decreases were
offset partially by increases in professional & outside services, driven by investments in new
product platforms in TSS, business and volume growth
in CS credit card processing and IB
brokerage, clearing and exchange transaction
processing. Also contributing to the increases were
an increase in other expense due to higher mortgage
reinsurance losses and mortgage servicing expense
due to increased delinquencies and
defaults in RFS; an increase in technology, communications and equipment expense
reflecting higher depreciation expense on owned
automobiles subject to operating leases in RFS, and
other technology-related investments across the
businesses; and, an increase in occupancy expense
partly for the expansion of RFS’ retail
distribution network. For a further discussion of
amortization of intangibles, refer to Note 18 on
pages 186–189 of this Annual Report.
For information on merger costs, refer to Note 11
on page 158 of this Annual Report.
2007 compared with 2006
Total noninterest expense for 2007 was $41.7
billion, up $2.9 billion, or 7%, from the prior
year. The increase was driven by higher
compensation expense, as well as investments
across the business segments and acquisitions.
The increase in compensation expense from 2006 was
primarily the result of investments and
acquisitions in the businesses, including
additional headcount from the Bank of New York
transaction; the classification of certain private
equity carried interest from principal
transactions revenue; the classification of certain
loan origination costs (loan origination costs
previously netted against revenue commenced being
recorded as an expense in the first quarter of
2007 due to the adoption of SFAS 159); and higher
performance-based incentives. Partially offsetting
these increases were business divestitures and
continuing business efficiencies.
Noncompensation expense increased from 2006 due to
higher professional & outside services primarily
reflecting higher brokerage expense and credit card
processing costs resulting from growth in
transaction volume, as well as investments in the
businesses and acquisitions. Also contributing to
the increase was higher other expense due to
increased net legal-related costs, reflecting a
lower level of insurance recoveries and increased
costs of credit card-related litigation, and other increases
driven by business growth and investments in the
businesses. Other noncompensation expense increases
also included higher occupancy expense driven by
ongoing investments in the businesses, in
particular, the retail distribution network and the
Bank of New York transaction; and higher technology,
communications and equipment expense due primarily
to higher depreciation expense on owned automobiles
subject to operating leases in RFS, and other
technology-related investments in the businesses to
support business growth. These increases were offset
partially by lower credit card marketing
expense; decreases due to the sale of the insurance
business at the beginning of the third quarter of
2006 and lower credit card fraud-related
losses, both in other expense. In addition, expense in
general was reduced by the effect of continuing
business efficiencies. For a discussion of
amortization of intangibles, refer to Note 18 on
pages 186–189 of this Annual Report.
For information on merger costs, refer to Note 11
on page 158 of this Annual Report.
The Firm’s income from continuing operations
before income tax expense (benefit), income tax
expense (benefit) and effective tax rate were as
follows for each of the periods indicated.
Year ended December 31,
(in millions, except rate)
2008
(a)
2007
2006
Income from continuing operations
before income tax expense (benefit)
$
2,773
$
22,805
$
19,886
Income tax expense (benefit)
(926
)
7,440
6,237
Effective tax rate
(33.4
)%
32.6
%
31.4
%
(a)
On September 25, 2008, JPMorgan Chase
acquired the banking operations of Washington
Mutual Bank. On May 30, 2008, the Bear Stearns merger was
consummated. Each of these
transactions was accounted for as a purchase and
their respective results of operations are included
in the Firm’s results from each respective
transaction date. For additional information on
these transactions, see Note 2 on pages 123–128 of
this Annual Report.
2008 compared with 2007
The decrease in the effective tax rate in 2008
compared with the prior year was the result of
significantly lower reported pretax income combined
with changes in the proportion of income subject to
U.S. federal taxes. Also contributing to the decrease
in the effective tax rate was increased business
tax credits and the realization of a $1.1 billion
benefit from the release of deferred tax
liabilities. These deferred tax liabilities were
associated with the undistributed earnings of
certain non-U.S. subsidiaries that were deemed to be
reinvested indefinitely. These decreases were
partially offset by
changes in state and local taxes, and equity losses
representing the Firm’s 49.4% ownership interest in
Bear Stearns’ losses from April 8 to May30, 2008, for which no income tax benefit was
recorded. For a further discussion of income
taxes, see Critical Accounting Estimates used by the
Firm on pages 107–111 and Note 28 on pages
197–199 of this Annual Report.
2007 compared with 2006
The increase in the effective tax rate for 2007, as compared with the prior year, was primarily the
result of higher reported pretax income combined
with changes in the proportion of income subject to
federal, state and local taxes. Also contributing to
the increase in the effective tax rate was the
recognition in 2006 of $367 million of benefits
related to the resolution of tax audits.
Income from discontinued operations
As a
result of the transaction with The Bank of
New York on October 1, 2006, the results of
operations of the selected corporate trust
businesses (i.e., trustee, paying agent, loan agency
and document management services) were reported as
discontinued operations.
Income from discontinued operations in 2006 was due
predominantly to a gain of $622 million from
exiting selected corporate trust businesses in the
fourth quarter of 2006. No income from discontinued
operations was recorded in 2008 or 2007.
Extraordinary gain
The Firm recorded an extraordinary gain of $1.9
billion in 2008 associated with the acquisition of
the banking operations of Washington Mutual. The
transaction is being accounted for under the
purchase method of accounting in accordance with
SFAS 141. The adjusted fair value of net assets of
the banking operations, after purchase accounting
adjustments, was higher than JPMorgan Chase’s purchase price. There were no extraordinary gains
recorded in 2007 or 2006.
EXPLANATION AND RECONCILIATION OF THE FIRM’S USE OF NON-GAAP FINANCIAL MEASURES
The Firm prepares its consolidated financial
statements using accounting principles generally
accepted in the United States of America
(“U.S. GAAP”); these financial statements appear on
pages 118–216 of this Annual Report. That
presentation, which is referred to as “reported
basis,” provides the reader with an
understanding of the Firm’s results that can be
tracked consistently from year to year and enables
a comparison of the Firm’s performance with other
companies’ U.S. GAAP financial statements.
In addition to analyzing the Firm’s results on a
reported basis, management reviews the Firm’s
results and the results of the lines of business on
a “managed” basis, which is a non-GAAP financial
measure. The Firm’s definition of managed basis
starts with the reported U.S. GAAP results and
includes certain reclassifications that assume
credit card loans securitized by CS remain on the
balance
sheet and presents revenue on a fully
taxable-equivalent (“FTE”) basis. These
adjustments do not have any impact on net income
as reported by the lines of business or by the
Firm as a whole.
The presentation of CS results on a managed basis
assumes that credit card loans that have been
securitized and sold in accordance with SFAS 140
remain on the Consolidated Balance Sheets and that
the earnings on the securitized loans are
classified in the same manner as the earnings on
retained loans recorded on the Consolidated Balance
Sheets. JPMorgan Chase uses the concept of managed
basis to evaluate the credit performance and
overall financial performance of the entire managed
credit card portfolio. Operations are funded and
decisions are made about allocating resources, such
as employees and capital, based upon managed
financial information. In addition, the same
underwriting standards and ongoing risk monitoring
The following summary table provides a reconciliation from the Firm’s reported U.S. GAAP
results to managed basis.
(Table continues on next page)
2008
2007
Fully
Fully
Year ended December 31,
tax-
tax-
(in millions, except
Reported
equivalent
Managed
Reported
equivalent
Managed
per share and ratio data)
results
Credit card(c)
adjustments
basis
results
Credit card(c)
adjustments
basis
Revenue
Investment banking fees
$
5,526
$
—
$
—
$
5,526
$
6,635
$
—
$
—
$
6,635
Principal transactions
(10,699
)
—
—
(10,699
)
9,015
—
—
9,015
Lending & deposit-related fees
5,088
—
—
5,088
3,938
—
—
3,938
Asset management, administration
and commissions
13,943
—
—
13,943
14,356
—
—
14,356
Securities gains (losses)
1,560
—
—
1,560
164
—
—
164
Mortgage fees and related income
3,467
—
—
3,467
2,118
—
—
2,118
Credit card income
7,419
(3,333
)
—
4,086
6,911
(3,255
)
—
3,656
Other income
2,169
—
1,329
3,498
1,829
—
683
2,512
Noninterest revenue
28,473
(3,333
)
1,329
26,469
44,966
(3,255
)
683
42,394
Net interest income
38,779
6,945
579
46,303
26,406
5,635
377
32,418
Total net revenue
67,252
3,612
1,908
72,772
71,372
2,380
1,060
74,812
Provision for credit losses
19,445
3,612
—
23,057
6,864
2,380
—
9,244
Provision for credit losses –
accounting conformity(a)
1,534
—
—
1,534
—
—
—
—
Noninterest expense
43,500
—
—
43,500
41,703
—
—
41,703
Income from continuing operations
before income tax expense
2,773
—
1,908
4,681
22,805
—
1,060
23,865
Income tax expense (benefit)
(926
)
—
1,908
982
7,440
—
1,060
8,500
Income from continuing operations
3,699
—
—
3,699
15,365
—
—
15,365
Income from discontinued operations
—
—
—
—
—
—
—
—
Income before extraordinary gain
3,699
—
—
3,699
15,365
—
—
15,365
Extraordinary gain
1,906
—
—
1,906
—
—
—
—
Net income
$
5,605
$
—
$
—
$
5,605
$
15,365
$
—
$
—
$
15,365
Diluted earningsper share(b)
$
0.84
$
—
$
—
$
0.84
$
4.38
$
—
$
—
$
4.38
Return on common equity(b)
2
%
—
%
—
%
2
%
13
%
—
%
—
%
13
%
Return on common equity less goodwill(b)
4
—
—
4
21
—
—
21
Return on assets(b)
0.21
NM
NM
0.20
1.06
NM
NM
1.01
Overhead ratio
65
NM
NM
60
58
NM
NM
56
Loans–Period-end
$
744,898
$
85,571
$
—
$
830,469
$
519,374
$
72,701
$
—
$
592,075
Total assets – average
1,791,617
76,904
—
1,868,521
1,455,044
66,780
—
1,521,824
(a)
2008 included an accounting conformity loan loss reserve provision related
to the acquisition of Washington Mutual’s banking operations.
(b)
Based on income from continuing operations.
(c)
Credit card securitizations affect CS. See pages 51–53 of this Annual Report for further
information.
are used for both loans on the Consolidated
Balance Sheets and securitized loans. Although
securitizations result in the sale of credit card
receivables to a trust, JPMorgan Chase retains the
ongoing customer relationships, as the customers may
continue to use their credit cards; accordingly, the
customer’s credit performance will affect both the
securitized loans and the loans retained on the
Consolidated Balance Sheets. JPMorgan Chase believes
managed basis information is useful to
investors, enabling them to understand both the
credit risks associated with the loans reported on
the Consolidated Balance Sheets and the Firm’s
retained interests in securitized loans. For a
reconciliation of reported to managed basis results
for CS, see CS segment results on pages 51–53 of
this Annual Report. For information regarding the
securitization process, and loans and residual
interests sold and securitized, see Note 16 on pages
168–176 of this Annual Report.
Total net revenue for each of the business segments
and the Firm is presented on a FTE
basis. Accordingly, revenue from tax-exempt
securities and investments that receive tax credits
is presented in the managed results on a basis
comparable to taxable securities and
investments. This non-GAAP financial measure allows
management to assess the comparability of revenue
arising from both taxable and tax-exempt
sources. The corresponding income tax impact related
to these items is recorded within income tax
expense.
Management also uses certain non-GAAP financial
measures at the business segment level because it
believes these other non-GAAP financial measures
provide information to investors about the
underlying operational performance and trends of
the particular business segment and therefore
facilitate a comparison of the business segment with the performance of its
competitors.
(Table continued from previous page)
2006
Fully
Reported
tax-equivalent
Managed
results
Credit card (c)
adjustments
basis
$
5,520
$
—
$
—
$
5,520
10,778
—
—
10,778
3,468
—
—
3,468
11,855
—
—
11,855
(543
)
—
—
(543
)
591
—
—
591
6,913
(3,509
)
—
3,404
2,175
—
676
2,851
40,757
(3,509
)
676
37,924
21,242
5,719
228
27,189
61,999
2,210
904
65,113
3,270
2,210
—
5,480
—
—
—
—
38,843
—
—
38,843
19,886
—
904
20,790
6,237
—
904
7,141
13,649
—
—
13,649
795
—
—
795
14,444
—
—
14,444
—
—
—
—
$
14,444
$
—
$
—
$
14,444
$
3.82
$
—
$
—
$
3.82
12
%
—
%
—
%
12
%
20
—
—
20
1.04
NM
NM
1.00
63
NM
NM
60
$
483,127
$
66,950
$
—
$
550,077
1,313,794
65,266
—
1,379,060
Calculation of certain U.S. GAAP and non-GAAP metrics
The table below reflects the formulas used to
calculate both the following U.S. GAAP and
non-GAAP measures:
Return on common equity
Net income*/ Average common stockholders’ equity
Return on common equity less goodwill(d)
Net income*/ Average common stockholders’ equity less goodwill
Return on assets
Reported: Net income / Total average assets
Managed: Net income / Total average managed
assets(e)
(including average
securitized credit card receivables)
Overhead ratio
Total noninterest expense / Total net revenue
* Represents net income applicable to common stock
(d)
The Firm uses return on common equity
less goodwill, a non-GAAP financial measure, to
evaluate the operating performance of the Firm
and to facilitate comparisons to competitors.
(e)
The Firm uses return on managed assets, a
non-GAAP financial measure, to evaluate the
overall performance of the managed credit card
portfolio, including securitized credit card
loans.
The Firm is managed on a line-of-business
basis. The business segment financial results
presented reflect the current organization of
JPMorgan Chase. There are six major reportable
business segments: the Investment Bank, Retail
Financial Services, Card Services, Commercial
Banking, Treasury & Securities Services and Asset
Management, as well as a Corporate/Private Equity
segment.
The business segments are determined based upon the
products and services provided, or the type of
customer served, and they reflect the manner in
which financial information is currently evaluated
by management. Results of these lines of business
are presented on a managed basis.
Business segment changes
Commencing October 1, 2008,RFS was reorganized into
the following two reporting segments: Retail
Banking and Consumer Lending. Previously, RFS
consisted of three reporting segments: Regional
Banking, Mortgage Banking and Auto Finance. The new
Retail Banking reporting segment now comprises
consumer banking and business banking activities,
which previously were reported in Regional Banking.
The new Consumer Lending reporting segment now
comprises: (a) the prior Mortgage Banking and Auto
Finance reporting segments,(b) the home equity,
student and other lending business activities which
were previously reported in the Regional Banking
reporting segment and (c) loan activity related to
prime mortgages that were originated by RFS, but
reported in the Corporate/Private Equity business
segment. This reorganization is reflected in this
Annual Report and the financial information for
prior periods has been revised to reflect the
changes as if they had been in effect throughout
all periods reported.
Description of business segment reporting methodology
Results of the business segments are intended to
reflect each segment as if it were essentially a
stand-alone business. The management reporting
process that derives business segment results
allocates income and expense using market-based
methodologies.
Business segment reporting methodologies used by
the Firm are discussed below. The Firm continues to
assess the assumptions, methodologies and reporting
classifications used for segment reporting, and
further refinements may be implemented in future
periods.
Revenue sharing
When business segments join efforts to sell
products and services to the Firm’s clients, the
participating business segments agree to share
revenue from those transactions. The segment
results reflect these revenue-sharing agreements.
Funds transfer pricing
Funds transfer pricing is used to allocate interest
income and expense to each business and transfer
the primary interest rate risk exposures to the
Treasury group within the Corporate/Private Equity
business segment. The allocation process is unique
to each business segment and considers the interest
rate risk, liquidity risk and regulatory
requirements of that segment’s stand-alone peers.
This process is overseen by the Firm’s
Asset-Liability Committee (“ALCO”). Business
segments may retain certain interest rate
exposures, subject to management approval, that
would be expected in the normal operation of a
similar peer business.
Capital allocation
Each business segment is allocated capital by
taking into consideration stand-alone peer
comparisons, economic risk measures and regulatory
capital requirements. The amount of capital
assigned to each business is referred to as equity.
Line of business equity increased during the second
quarter of 2008 in IB and AM due to the Bear
Stearns merger and, for AM, the purchase of the
additional equity interest in Highbridge. At the
end of the third quarter of 2008, equity was
increased for each line of business with a view
toward the future implementation of the new Basel
II capital rules. For further details on these
rules, see Basel II on page 72 of this Annual
Report. In addition, equity allocated to RFS,CS and
CB was increased as a result of the Washington
Mutual transaction. For a further discussion, see
Capital management—Line of business equity on page
70 of this Annual Report.
Expense allocation
Where business segments use services provided by
support units within the Firm, the costs of those
support units are allocated to the business
segments. The expense is allocated based upon
their actual cost or the lower of actual cost or
market, as well as upon usage of the services
provided. In contrast, certain other expense
related to certain corporate functions, or to
certain technology and operations, are not
allocated to the business segments and are
retained in Corporate. Retained expense includes:
parent company costs that would not be incurred if
the segments were stand-alone businesses; adjustments to align certain corporate
staff, technology and operations allocations with
market prices; and other one-time items not
aligned with the business segments.
Segment results – Managed basis(a)(b)
The following table summarizes the business segment results for the periods indicated.
Year ended December 31,
Total net revenue
Noninterest expense
(in millions, except ratios)
2008
2007
2006
2008
2007
2006
Investment Bank
$
12,214
$
18,170
$
18,833
$
13,844
$
13,074
$
12,860
Retail Financial Services
23,520
17,305
14,825
12,077
9,905
8,927
Card Services
16,474
15,235
14,745
5,140
4,914
5,086
Commercial Banking
4,777
4,103
3,800
1,946
1,958
1,979
Treasury & Securities Services
8,134
6,945
6,109
5,223
4,580
4,266
Asset Management
7,584
8,635
6,787
5,298
5,515
4,578
Corporate/Private Equity
69
4,419
14
(28
)
1,757
1,147
Total
$
72,772
$
74,812
$
65,113
$
43,500
$
41,703
$
38,843
Year ended December 31,
Net income (loss)
Return on equity
(in millions, except ratios)
2008
2007
2006
2008
2007
2006
Investment Bank
$
(1,175
)
$
3,139
$
3,674
(5
)%
15
%
18
%
Retail Financial Services
880
2,925
3,213
5
18
22
Card Services
780
2,919
3,206
5
21
23
Commercial Banking
1,439
1,134
1,010
20
17
18
Treasury & Securities Services
1,767
1,397
1,090
47
47
48
Asset Management
1,357
1,966
1,409
24
51
40
Corporate/Private Equity(c)
557
1,885
842
NM
NM
NM
Total
$
5,605
$
15,365
$
14,444
4
%
13
%
13
%
(a)
Represents reported results on a tax-equivalent basis and excludes the impact of credit
card securitizations.
(b)
On September 25, 2008, JPMorgan Chase acquired the banking operations of Washington Mutual Bank. On
May 30, 2008, the Bear Stearns merger was consummated. Each of these transactions was accounted for
as a purchase and their respective results of operations are included in the Firm’s results from
each respective transaction date. For additional information on these transactions, see Note 2 on
pages 123-128 of this Annual Report.
(c)
Net income included an extraordinary gain of $1.9 billion related to the Washington Mutual
transaction for 2008 and income from discontinued operations of $795 million for 2006.
J.P. Morgan is one of the world’s leading
investment banks, with deep client relationships
and broad product capabilities. The Investment
Bank’s clients are corporations, financial
institutions, governments and institutional
investors. The Firm offers a full range of
investment banking products and services in all
major capital markets, including advising on
corporate strategy and structure, capital
raising in equity and debt markets,
sophisticated risk management, market-making in
cash securities and derivative instruments,
prime brokerage and research. IB also selectively commits the
Firm’s own capital to principal investing and
trading activities.
On
May 30, 2008, JPMorgan Chase merged with The Bear Stearns
Companies, Inc. The merger provided IB with a leading global prime
brokerage business and expanded the existing energy platform. It also
strengthened IB's franchise in Equity and Fixed Income Markets, as well
as client coverage.
Selected income statement data
Year ended December 31,
(in millions, except ratios)
2008(g)
2007
2006
Revenue
Investment banking fees
$
5,907
$
6,616
$
5,537
Principal transactions(a)
(7,042
)
4,409
9,512
Lending & deposit-related fees
463
446
517
Asset management, administration
and commissions
3,064
2,701
2,240
All other income(b)
(462
)
(78
)
528
Noninterest revenue
1,930
14,094
18,334
Net interest income(c)
10,284
4,076
499
Total net revenue(d)
12,214
18,170
18,833
Provision for credit losses
2,015
654
191
Credit reimbursement from TSS(e)
121
121
121
Noninterest expense
Compensation expense
7,701
7,965
8,190
Noncompensation expense
6,143
5,109
4,670
Total noninterest expense
13,844
13,074
12,860
Income (loss) before income tax
expense (benefit)
(3,524
)
4,563
5,903
Income tax expense (benefit)(f)
(2,349
)
1,424
2,229
Net income (loss)
$
(1,175
)
$
3,139
$
3,674
Financial ratios
ROE
(5
)%
15
%
18
%
ROA
(0.14
)
0.45
0.57
Overhead ratio
113
72
68
Compensation expense as
% of total net revenue
63
44
41
(a)
The 2008 results include net markdowns on
mortgage-related exposures and leveraged lending
funded and unfunded commitments of $5.9 billion
and $4.7 billion, respectively, compared with $1.4
billion and $1.3 billion, respectively, in 2007.
(b)
All other income for 2008 decreased from the
prior year due to increased revenue sharing
agreements with other business segments. All other
income for 2007 decreased from the prior year due
mainly to losses on loan sales and lower gains on
sales of assets.
(c)
Net interest income for 2008 increased from the
prior year due to an increase in interest-earning
assets, including the addition of the Bear Stearns’
Prime Services business combined with wider spreads
on certain fixed income products. The increase in
2007 from the prior year was due primarily to an
increase in interest-earning assets.
(d)
Total net
revenue included tax-equivalent adjustments,
predominantly due to income tax credits related to
affordable housing investments and tax-exempt
income from municipal bond investments of $1.7 billion, $927 million and $802 million for 2008,
2007 and 2006,respectively.
(e)
TSS is charged a credit reimbursement related
to certain exposures managed within IB credit
portfolio on behalf of clients shared with TSS.
(f)
The income tax benefit in 2008 includes the
result of reduced deferred tax liabilities on
overseas earnings.
(g)
Results for 2008 include seven months of the
combined Firm’s (JPMorgan Chase’s and Bear
Stearns’) results and five months of heritage
JPMorgan Chase results. All prior periods reflect
heritage JPMorgan Chase results.
The following table provides IB’s total net revenue by business segment.
Year ended December 31,
(in millions)
2008(d)
2007
2006
Revenue by business
Investment banking fees:
Advisory
$
2,008
$
2,273
$
1,659
Equity underwriting
1,749
1,713
1,178
Debt underwriting
2,150
2,630
2,700
Total investment banking fees
5,907
6,616
5,537
Fixed income markets(a)
1,957
6,339
8,736
Equity markets(b)
3,611
3,903
3,458
Credit portfolio(c)
739
1,312
1,102
Total net revenue
$
12,214
$
18,170
$
18,833
Revenue by region
Americas
$
2,530
$
8,165
$
9,601
Europe/Middle East/Africa
7,681
7,301
7,421
Asia/Pacific
2,003
2,704
1,811
Total net revenue
$
12,214
$
18,170
$
18,833
(a)
Fixed income markets include client and
portfolio management revenue related to both
market-making and proprietary risk-taking across
global fixed income markets, including foreign
exchange, interest rate, credit and commodities
markets.
(b)
Equities markets include client and portfolio
management revenue related to market-making and
proprietary risk-taking across global equity
products, including cash instruments, derivatives
and convertibles.
(c)
Credit portfolio revenue includes net interest
income, fees and the impact of loan sales activity,
as well as gains or losses on securities received
as part of a loan restructuring, for IB’s credit
portfolio. Credit portfolio revenue also includes
the results of risk management related to the
Firm’s lending and derivative activities, and
changes in the credit valuation adjustment, which
is the component of the fair value of a derivative
that reflects the credit quality of the
counterparty. Additionally, credit portfolio
revenue incorporates an adjustment to the valuation
of the Firm’s derivative liabilities as a result of
the adoption of SFAS 157 on January 1, 2007. See
pages 80–99 of the Credit Risk Management section
of this Annual Report for further discussion.
(d)
Results for 2008 include seven months of the
combined Firm’s (JPMorgan Chase’s and Bear
Stearns’) results and five months of heritage
JPMorgan Chase results. All prior periods reflect
heritage JPMorgan Chase results.
2008 compared with 2007
Net loss was $1.2 billion, a decrease of $4.3
billion from the prior year, driven by lower total
net revenue, a higher provision for credit losses
and higher noninterest expense, partially offset by
a reduction in deferred tax liabilities on overseas
earnings.
Total net revenue was $12.2 billion, down $6.0
billion, or 33%, from the prior year. Investment
banking fees were $5.9 billion, down 11% from the
prior year, driven by lower debt underwriting and
advisory fees reflecting reduced market activity.
Debt underwriting fees were $2.2 billion, down 18%
from the prior year, driven by lower loan
syndication and bond underwriting fees. Advisory
fees of $2.0 billion declined 12% from the prior
year. Equity underwriting fees were $1.7 billion,
up 2%
from the prior year driven by improved market
share. Fixed Income Markets revenue was $2.0
billion, compared with $6.3 billion in the prior
year. The decrease was driven by $5.9
billion of net markdowns on mortgage-related
exposures and $4.7 billion of net markdowns on
leveraged lending funded and unfunded commitments.
Revenue was also adversely impacted by additional
losses and cost to risk reduce related to Bear
Stearns’ positions. These results were offset by
record performance in rates and currencies, credit
trading, commodities and emerging markets as well
as $814 million of gains from the widening of the
Firm’s credit spread on certain structured
liabilities and derivatives. Equity Markets revenue
was $3.6 billion, down 7% from the prior year,
reflecting weak trading results, partially offset
by strong client revenue across products including
prime services, as well as $510 million of gains
from the widening of the Firm’s credit spread on
certain structured liabilities and derivatives.
Credit portfolio revenue was $739 million, down
44%, driven by losses from widening counterparty
credit spreads.
The provision for credit
losses was $2.0 billion,
an increase of $1.4 billion from the prior year,
predominantly reflecting a higher allowance for
credit losses, driven by a weakening credit
environment, as well as the effect of the transfer
of $4.9 billion of funded and unfunded leveraged
lending commitments to retained loans from
held-for-sale in the first quarter of 2008. Net
charge-offs for the year were $105 million,
compared with $36 million in the prior year. Total
nonperforming assets were $2.5 billion, an increase
of $2.0 billion compared with the prior year,
reflecting a weakening credit environment. The
allowance for loan losses to average loans was
4.71% for 2008, compared with a ratio of 2.14% in
the prior year.
Noninterest expense was $13.8 billion, up $770
million, or 6%,from the prior year, reflecting
higher noncompensation expense driven primarily by
additional expense relating to the Bear Stearns
merger, off-set partially by lower
performance-based compensation expense.
Return on equity was a negative 5% on $26.1 billion
of average allocated capital, compared with 15% on
$21.0 billion in the prior year.
2007 compared with 2006
Net income was $3.1 billion, a decrease of $535
million, or 15%, from the prior year. The decrease
reflected lower fixed income revenue, a higher
provision for credit losses and increased
noninterest expense, partially offset by record
investment banking fees and equity markets revenue.
Total net revenue was $18.2 billion, down $663
million, or 4%,from the prior year. Investment
banking fees were $6.6 billion, up 19% from the
prior year, driven by record
fees across advisory and equity underwriting,
partially offset by lower debt underwriting fees.
Advisory fees were $2.3 billion, up 37%, and equity
underwriting fees were $1.7 billion, up 45%; both
were driven by record performance across all
regions. Debt underwriting fees of $2.6 billion
declined 3%, reflecting lower loan syndication and
bond underwriting fees, which were negatively
affected by market conditions in the second half of
the year. Fixed Income Markets revenue decreased
27% from the prior year. The decrease was due to
net markdowns of $1.4 billion on subprime
positions, including subprime CDOs and net
markdowns of $1.3 billion on leveraged lending
funded loans and unfunded commitments. Fixed Income
Markets revenue also decreased due to markdowns in
securitized products on nonsubprime mortgages and
weak credit trading performance. These lower
results were offset partially by record revenue in
currencies and strong revenue in rates. Equity
Markets revenue was $3.9 billion, up 13%, benefiting
from strong client activity and record trading
results across all products. Credit Portfolio
revenue was $1.3 billion, up 19%, primarily due to
higher revenue from risk management activities,
partially offset by lower gains from loan sales and
workouts.
The provision for credit losses was $654 million,
an increase of $463 million from the prior year.
The change was due to a net increase of $532
million in the allowance for credit losses,
primarily due to portfolio activity, which included
the effect of a weakening credit environment, and
an increase in allowance for unfunded leveraged
lending commitments, as well as portfolio growth.
In addition, there were $36 million of net
charge-offs in 2007, compared with $31 million of
net recoveries in the prior year. The allowance for
loan losses to average loans was 2.14% for
2007, compared with a ratio of 1.79% in the prior
year.
Noninterest expense was $13.1 billion, up $214
million, or 2%, from the prior year.
Return on equity was 15% on $21.0 billion of
allocated capital compared with 18% on $20.8
billion in 2006.
Selected metrics
Year ended December 31,
(in millions, except headcount)
2008
2007
2006
Selected balance sheet data
(period-end)
Equity
$
33,000
$
21,000
$
21,000
Selected balance sheet data
(average)
Total assets
$
832,729
$
700,565
$
647,569
Trading assets–debt and
equity instruments(a)
350,812
359,775
275,077
Trading assets–derivative
receivables
112,337
63,198
54,541
Loans:
Loans retained(b)
73,108
62,247
58,846
Loans held-for-sale and loans
at fair value(a)
18,502
17,723
21,745
Total loans
91,610
79,970
80,591
Adjusted assets(c)
679,780
611,749
527,753
Equity
26,098
21,000
20,753
Headcount
27,938
25,543
23,729
(a)
As a result of the adoption of SFAS 159 in
the first quarter of 2007, $11.7 billion of loans
were reclassified to trading assets. Loans
held-for-sale and loans at fair value were excluded
when calculating the allowance coverage ratio and
net charge-off (recovery) rate.
(b)
Loans retained included credit portfolio
loans, leveraged leases and other accrual loans,
and excluded loans at fair value.
(c)
Adjusted assets, a non-GAAP financial measure,
equals total assets minus (1) securities purchased
under resale agreements and securities borrowed
less securities sold, not yet purchased; (2) assets
of variable interest entities (“VIEs”) consolidated
under FIN 46R; (3) cash and securities segregated
and on deposit for regulatory and other
purposes; (4) goodwill and intangibles; (5)
securities received as collateral; and (6)
investments purchased under the Asset-Backed
Commercial Paper Money Market Mutual Fund Liquidity
Facility. The amount of adjusted assets is
presented to assist the reader in comparing IB’s
asset and capital levels to other investment banks
in the securities industry. Asset-to-equity
leverage ratios are commonly used as one measure to
assess a company’s capital adequacy. IB believes an
adjusted asset amount that excludes the assets
discussed above, which were considered to have a
low risk profile, provides a more meaningful
measure of balance sheet leverage in the securities
industry.
Allowance for loan losses to
average loans(a)(b)(c)
4.71
(h)
2.14
(h)
1.79
Allowance for loan losses to
nonperforming loans(a)
301
439
461
Nonperforming loans to average
loans
1.28
0.44
0.29
Market risk–average trading
and credit portfolio VaR
– 99% confidence level(d)
Trading activities:
Fixed income
$
181
$
80
$
56
Foreign exchange
34
23
22
Equities
57
48
31
Commodities and other
32
33
45
Diversification(e)
(108
)
(77
)
(70
)
Total trading VaR(f)
196
107
84
Credit portfolio VaR(g)
69
17
15
Diversification(e)
(63
)
(18
)
(11
)
Total trading and credit
portfolio VaR
$
202
$
106
$
88
(a)
Nonperforming loans included loans
held-for-sale and loans at fair value of $32
million, $50 million and $3 million at December31, 2008, 2007 and 2006, respectively, which were
excluded from the allowance coverage ratios.
Nonperforming loans at December 31, 2006, excluded
distressed loans held-for-sale that were purchased
as part of IB’s proprietary activities. As a result
of the adoption of SFAS 159 in the first quarter of
2007, these loans were reclassified to trading
assets.
(b)
As a result of the adoption of SFAS 159 in the
first quarter of 2007, $11.7 billion of loans were
reclassified to trading assets.
(c)
Loans held-for-sale and loans at fair value
were excluded when calculating the allowance
coverage ratio and net charge-off (recovery)
rate.
(d)
Results for 2008 include seven months of the
combined Firm’s (JPMorgan Chase’s and Bear
Stearns’) results and five months of heritage
JPMorgan Chase results. All prior periods reflect
heritage JPMorgan Chase results. For a more
complete description of value-at-risk (“VaR”), see
pages 100–103 of this Annual Report.
(e)
Average VaRs were less than the sum of the VaRs
of their market risk components, which was due to
risk offsets resulting from portfolio
diversification. The diversification effect
reflected the fact that the risks were not
perfectly correlated. The risk of a portfolio of
positions is usually less than the sum of the risks
of the positions themselves.
(f)
Trading VaR
includes predominantly all trading activities in
IB; however, particular risk parameters of certain
products are not fully captured, for example,
correlation risk. Trading VaR does not include VaR related to
held-for-sale funded loans and unfunded
commitments, nor the debit valuation adjustments
(“DVA”) taken on derivative and structured
liabilities to reflect the credit quality of the
Firm. See the DVA Sensitivity table on page 103
of this Annual Report for further details.
Trading VaR also does not include the MSR
portfolio or VaR related to other corporate
functions, such as Corporate/Private Equity.
Beginning in the fourth quarter of 2008, trading
VaR includes the estimated credit spread
sensitivity of certain mortgage products.
(g)
Included VaR on derivative credit valuation
adjustments (“CVA”), hedges of the CVA and
mark-to-market hedges of the retained loan
portfolio, which were all reported in principal
transactions revenue. This VaR does not include the
retained loan portfolio.
(h)
Excluding the impact
of a loan originated in March 2008 to Bear Stearns,
the adjusted ratio would be 4.84% for 2008. The
average balance of the loan extended to Bear
Stearns was $1.9 billion for 2008. The allowance for
loan losses to period-end loans was 4.83% and 1.92%
at December 31, 2008 and 2007, respectively.
Market shares and rankings(a)
2008
2007
2006
Market
Market
Market
December 31,
share
Rankings
share
Rankings
share
Rankings
Global debt, equity
and equity-related
10%
#1
8%
#2
7%
#2
Global syndicated loans
12
1
13
1
14
1
Global long-term debt (b)
9
2
7
3
6
3
Global equity and
equity-related(c)
12
1
9
2
7
6
Global announced
M&A(d)
27
2
27
4
26
4
U.S. debt, equity and
equity-related
16
1
10
2
9
2
U.S. syndicated loans
26
1
24
1
26
1
U.S. long-term debt(b)
15
1
10
2
9
2
U.S. equity and
equity-related(c)
16
1
11
5
8
6
U.S. announced M&A(d)
33
3
28
3
29
3
(a)
Source: Thomson Reuters. The results for 2008 are pro forma for the Bear Stearns
merger. The results for 2007 and 2006 represent heritage JPMorgan Chase only.
(b)
Includes asset-backed securities, mortgage-backed securities and municipal securities.
(c)
Includes rights offerings; U.S. domiciled equity and equity-related transactions.
(d)
Global announced M&A is based upon rank value; all other rankings are based
upon proceeds, with full credit to each book manager/equal if joint. Because of joint
assignments, market share of all participants will add up to more than 100%.
Global and U.S. announced M&A market share and rankings for 2007 and 2006
include transactions withdrawn since December 31, 2007 and 2006. U.S.
announced M&A represents any U.S. involvement ranking.
According to Thomson Reuters, in 2008, the Firm
improved its positions to #1 in Global Debt,
Equity and Equity-related transactions and Global
Equity and Equity-related transactions; and
improved its position to #2 in Global Long-term
Debt and Global Announced M&A. The Firm maintained
its #1 position in Global Syndicated Loans.
According to Dealogic, the Firm was ranked #1
in Investment Banking fees generated during
2008, based upon revenue.
Retail Financial Services, which includes
the Retail Banking and Consumer Lending
reporting segments, serves consumers and
businesses through multiple channels.
Customers can use more than 5,400 bank branches
(third-largest nationally),14,500 ATMs
(second-largest nationally) as well as online
and mobile banking. More than 21,400 branch
salespeople assist customers with checking and
savings accounts, mortgages, home equity and
business loans,and investments across the
23-state footprint from New York and Florida to
California. Consumers also can obtain loans
through more than 16,000 auto dealerships and
4,800 schools and universities nationwide.
On September 25, 2008, JPMorgan Chase acquired the
banking operations of Washington Mutual from the
FDIC for $1.9 billion through a purchase of
substantially all of the assets and assumption of
specified liabilities of Washington Mutual.
Washington Mutual’s banking operations consisted
of a retail bank network of 2,244 branches, a
nationwide credit card lending business, a
multi-family and commercial real estate lending
business, and nationwide mortgage banking
activities. The transaction expanded the Firm’s
U.S. consumer branch network in California,
Florida, Washington,
Georgia, Idaho, Nevada and Oregon and created the
nation’s third-largest branch network.
During the first quarter of 2006, RFS completed the
purchase of Collegiate Funding Services, which
contributed a student loan servicing capability and
provided an entry into the Federal Family Education
Loan Program consolidation market. On July1, 2006, RFS sold its life insurance and annuity
underwriting businesses to Protective Life
Corporation. On October 1, 2006, JPMorgan Chase
completed the Bank of New York transaction,
significantly strengthening RFS’ distribution
network in the New York tri-state area.
Selected income statement data
Year ended December 31,
(in millions)
2008
2007
2006
Revenue
Lending & deposit-related fees
$
2,546
$
1,881
$
1,597
Asset management, administration
and commissions
1,510
1,275
1,422
Securities gains (losses)
—
1
(57
)
Mortgage fees and related income(a)
3,621
2,094
618
Credit card income
939
646
523
Other income
739
882
557
Noninterest revenue
9,355
6,779
4,660
Net interest income
14,165
10,526
10,165
Total net revenue
23,520
17,305
14,825
Provision for credit losses
9,905
2,610
561
Noninterest expense
Compensation expense(a)
5,068
4,369
3,657
Noncompensation expense(a)
6,612
5,071
4,806
Amortization of intangibles
397
465
464
Total noninterest expense
12,077
9,905
8,927
Year ended December 31,
(in millions, except ratios)
2008
2007
2006
Income before income
tax expense
1,538
4,790
5,337
Income tax expense
658
1,865
2,124
Net income
$
880
$
2,925
$
3,213
Financial ratios
ROE
5
%
18
%
22
%
Overhead ratio
51
57
60
Overhead ratio excluding core
deposit intangibles(b)
50
55
57
(a)
The Firm adopted SFAS 159 in the first quarter of 2007. As a result, beginning in
the first quarter of 2007, certain loan-origination costs have been classified as
expense.
(b)
Retail Financial Services uses the overhead ratio (excluding the amortization of core
deposit intangibles (“CDI”)), a non-GAAP financial measure, to evaluate the underlying expense trends of the business. Including CDI amortization expense in the
overhead ratio calculation results in a higher overhead ratio in the earlier years and
a lower overhead ratio in later years; this method would result in an improving
overhead ratio over time, all things remaining equal. This non-GAAP ratio excludes
Retail Baking’s core deposit intangible amortization expense related to the Bank of
New York transaction and the Bank One merger of $394 million, $460 million and
$458 million for the years ended December 31, 2008, 2007 and 2006, respectively.
2008 compared with 2007
Net income was $880 million, a decrease of $2.0 billion, or 70%, from the prior year, as a significant increase in
the provision for credit losses was partially offset by positive MSR risk management results and
the positive impact of the Washington Mutual transaction.
Total net revenue was $23.5 billion,
an increase of $6.2 billion, or 36%, from the prior year. Net
interest income was $14.2 billion, up $3.6 billion, or 35%, benefiting from the Washington Mutual
transaction, wider loan and deposit spreads, and higher loan and deposit balances. Noninterest
revenue was $9.4 billion, up $2.6 billion, or 38%, as positive MSR risk management results, the
impact of the Washington Mutual transaction, higher mortgage origination volume and higher
deposit-related fees were partially offset by an increase in reserves related to the repurchase of
previously sold loans and markdowns on the mortgage warehouse.
The provision for credit losses was $9.9 billion, an increase of $7.3 billion from the prior year.
Delinquency rates have increased due to overall weak economic conditions, while housing price
declines have continued to drive increased loss severities, particularly for high loan-to-value
home equity and mortgage loans. The provision includes $4.7 billion in additions to the allowance
for loan losses for the heritage Chase home equity and mortgage portfolios. Home equity net
charge-offs were $2.4 billion (2.23% net charge-off rate; 2.39% excluding purchased credit-impaired
loans), compared with $564 million (0.62% net charge-off rate) in the prior year. Subprime
mortgage net charge-offs were $933 million (5.49% net charge-off rate; 6.10% excluding purchased
credit-impaired loans),compared with $157 million (1.55% net charge-off rate) in the prior year.
Prime mortgage net charge-offs were $526 million (1.05% net charge-off rate; 1.18% excluding
purchased credit-impaired loans), compared with $33 million (0.13% net charge-off rate) in the prior
year. The provision for credit losses was also affected by an increase in estimated losses for the
auto, student and business banking loan portfolios.
Total noninterest expense was $12.1 billion, an
increase of $2.2 billion, or 22%, from the prior
year, reflecting the impact of the Washington
Mutual transaction, higher mortgage reinsurance
losses, higher mortgage servicing expense and
investments in the retail distribution network.
2007 compared with 2006
Net income was $2.9 billion, a decrease of $288
million, or 9%, from the prior year, as a decline
in Consumer Lending was offset partially by
improved results in Retail Banking.
Total net revenue was $17.3 billion, an increase of
$2.5 billion, or 17%, from the prior year. Net
interest income was $10.5 billion, up $361 million,
or 4%, due to the Bank of New York transaction,
wider loan spreads and higher deposit balances.
These benefits were offset partially by the sale of
the insurance business and a shift to
narrower–spread deposit products. Noninterest
revenue was $6.8 billion, up $2.1 billion,
benefiting from positive MSR risk management
results; an increase in deposit-related fees; and
the absence of a prior-year $233 million loss
related to $13.3 billion of mortgage loans
transferred to held-for-sale. Noninterest revenue
also benefited from the classification of certain
mortgage loan origination costs as expense (loan
origination costs previously netted against revenue
commenced being recorded as an expense in the first
quarter of 2007 due to the adoption of SFAS 159).
The provision for credit losses was $2.6 billion,
compared with $561 million in the prior year. The
current year provision includes a net increase of
$1.0 billion in the allowance for loan losses
related to home equity loans as continued weak
housing prices have resulted in an increase in
estimated losses for high loan-to-value loans. Home
equity net charge-offs were $564 million (0.62% net
charge-off rate), compared with $143 million (0.18%
net charge-off rate) in the prior year. In
addition, the current-year provision includes a
$166 million increase in the allowance for loan
losses related to subprime mortgage loans,
reflecting an increase in estimated losses and
growth in the portfolio. Subprime mortgage net
charge-offs were $157 million (1.55% net charge-off
rate),compared with $47 million (0.34% net
charge-off rate) in the prior year.
Total noninterest expense was $9.9 billion, an
increase of $978 million, or 11%, from the prior
year due to the Bank of New York transaction; the
classification of certain loan origination costs as
expense due to the adoption of SFAS 159;
investments in the retail distribution network; and
higher mortgage production and servicing expense.
These increases were offset partially by the sale
of the insurance business.
Selected metrics
Year ended December 31,
(in millions, except headcount
and ratios)
2008
2007
2006
Selected
balance sheet data –
period-end
Assets
$
419,831
$
256,351
$
237,887
Loans:
Loans retained
368,786
211,324
180,760
Loans held-for-sale and loans
at fair value(a)
9,996
16,541
32,744
Total loans
378,782
227,865
213,504
Deposits
360,451
221,129
214,081
Equity
25,000
16,000
16,000
Selected balance sheet data
(average)
Assets
$
304,442
$
241,112
$
231,566
Loans:
Loans retained
257,083
191,645
187,753
Loans held-for-sale and loans
at fair value(a)
17,056
22,587
16,129
Total loans
274,139
214,232
203,882
Deposits
258,362
218,062
201,127
Equity
19,011
16,000
14,629
Headcount
102,007
69,465
65,570
Credit data and quality
statistics
Net charge-offs
$
4,877
$
1,350
$
576
Nonperforming loans(b)(c)(d)(e)
6,784
2,828
1,677
Nonperforming assets(b)(c)(d)(e)
9,077
3,378
1,902
Allowance for loan losses
8,918
2,668
1,392
Net charge-off rate(f)
1.90
%
0.70
%
0.31
%
Net charge-off rate excluding
credit-impaired loans(f)(g)
2.08
0.70
0.31
Allowance for loan losses to
ending loans(f)
2.42
1.26
0.77
Allowance for loan losses to ending
loans excluding purchased
credit-impaired loans(f)(g)
3.19
1.26
0.77
Allowance for loan losses to
nonperforming loans(f)
136
97
89
Nonperforming loans to total loans
1.79
1.24
0.79
(a)
Loans included prime mortgage loans originated with the intent to sell, which, for
new originations on or after January 1, 2007, were accounted for at fair value under
SFAS 159. These loans, classified as trading assets on the Consolidated Balance
Sheets, totaled $8.0 billion and $12.6 billion at December 31, 2008 and 2007,
respectively. Average loans included prime mortgage loans, classified as trading
assets on the Consolidated Balance Sheets, of $14.2 billion and $11.9 billion for the
years ended December 31, 2008 and 2007, respectively.
(b)
Excludes purchased credit-impaired loans accounted for
under SOP 03-3 that were acquired as part of the Washington Mutual transaction.
These loans were accounted for on a pool basis and the pools are considered to be
performing under SOP 03-3.
(c)
Nonperforming loans and assets included loans held-for-sale and loans accounted
for at fair value of $236 million, $69 million and $116 million at December 31,2008, 2007 and 2006, respectively. Certain of these loans are classified as trading
assets on the Consolidated Balance Sheets.
(d)
Nonperforming loans and assets excluded (1) loans eligible for repurchase as well
as loans repurchased from Governmental National Mortgage Association (“GNMA”)
pools that are insured by U.S. government agencies of $3.3 billion, $1.5 billion and
$1.2 billion at December 31, 2008, 2007 and 2006, respectively, and (2) student
loans that are 90 days past due and still accruing, which are insured by U.S. government agencies under the Federal Family Education Loan Program of $437 million,
$417 million and $387 million at December 31, 2008, 2007 and 2006, respectively.
These amounts were excluded, as reimbursement is proceeding normally.
During the second quarter of 2008, the policy for classifying subprime mortgage
and home equity loans as nonperforming was changed to conform to all other
home lending products. Amounts for 2007 have been revised to reflect
this change. Amounts for 2006 have not been revised as the impact
was not material.
(f)
Loans held-for-sale and loans accounted for at fair value were excluded when calculating the allowance coverage ratio and the net charge-off rate.
(g)
Excludes the impact of purchased credit-impaired loans accounted for under SOP
03-3 that were acquired as part of the Washington Mutual transaction at December31, 2008. These loans were accounted for at fair value on the acquisition date,
which included the impact of credit losses over the remaining life of the portfolio.
Accordingly, no allowance for loan losses has been recorded for these loans.
Retail Banking
Selected income statement data
Year ended December 31,
(in millions, except ratios)
2008
2007
2006
Noninterest revenue
$
4,951
$
3,763
$
3,259
Net interest income
7,659
6,193
5,698
Total net revenue
12,610
9,956
8,957
Provision for credit losses
449
79
114
Noninterest expense
7,232
6,166
5,667
Income before income
tax expense
4,929
3,711
3,176
Net income
$
2,982
$
2,245
$
1,922
Overhead ratio
57
%
62
%
63
%
Overhead ratio excluding core
deposit intangibles(a)
54
57
58
(a)
Retail Banking uses the overhead ratio (excluding the amortization of core deposit
intangibles (“CDI”)), a non-GAAP financial measure, to evaluate the underlying
expense trends of the business. Including CDI amortization expense in the overhead
ratio calculation results in a higher overhead ratio in the earlier years and a lower
overhead ratio in later years; this method would result in an improving overhead
ratio over time, all things remaining equal. This ratio excludes Retail Baking’s core
deposit intangible amortization expense related to the Bank of New York transaction and the Bank One merger of $394 million, $460 million and $458 million for
the years ended December 31, 2008, 2007 and 2006, respectively.
2008 compared with 2007
Retail Banking net income was $3.0 billion, up $737
million, or 33%, from the prior year. Total net
revenue was $12.6 billion, up $2.7 billion, or 27%,
reflecting the impact of the Washington Mutual
transaction, wider deposit spreads, higher
deposit-related fees, and higher deposit balances.
The provision for credit losses was $449 million,
compared with $79 million in the prior year,
reflecting an increase in the allowance for loan
losses for Business Banking loans due to higher
estimated losses on the portfolio. Noninterest
expense was $7.2 billion, up $1.1 billion, or 17%,
from the prior year, due to the Washington Mutual
transaction and investments in the retail
distribution network.
2007 compared with 2006
Retail Banking net income was $2.2 billion, an
increase of $323 million, or 17%, from the prior
year. Total net revenue was $10.0 billion, up $1.0
billion, or 11%, benefiting from the following: the
Bank of New York
transaction; increased deposit-related fees; and
growth in deposits. These benefits were offset
partially by a shift to narrower-spread deposit
products. The provision for credit losses was $79
million, compared with $114 million in the prior
year. Noninterest expense was $6.2 billion, up $499
million, or 9%, from the prior year, driven by the
Bank of New York transaction and investments in the
retail distribution network.
Selected metrics
Year ended December 31,
(in billions, except ratios and
where otherwise noted)
2008
2007
2006
Business metrics
Selected ending balances
Business banking origination
volume
$
5.5
$
6.9
$
5.7
End-of-period loans owned
18.4
15.6
14.0
End-of-period deposits
Checking
$
109.2
$
66.9
$
67.1
Savings
144.0
96.0
91.5
Time and other
89.1
48.6
43.2
Total end-of-period deposits
342.3
211.5
201.8
Average loans owned
$
16.7
$
14.9
$
13.4
Average deposits
Checking
$
77.1
$
65.8
$
62.7
Savings
114.3
97.1
89.7
Time and other
53.2
43.8
37.5
Total average deposits
244.6
206.7
189.9
Deposit margin
2.89
%
2.72
%
2.74
%
Average assets
$
26.3
$
25.0
$
20.5
Credit data and quality statistics
(in millions, except ratio)
2008 compared with 2007
Consumer Lending net loss was $2.1 billion,
compared with net income of $680 million in the
prior year. Total net revenue was $10.9 billion, up
$3.6 billion, or 48%, driven by higher mortgage
fees and related income (due primarily to positive
MSR risk management results), the impact of the
Washington Mutual transaction, higher loan balances
and wider loan spreads.
The increase in mortgage fees and related income
was primarily driven by higher net mortgage
servicing revenue. Mortgage production revenue of
$898 million was up $18 million, as higher mortgage
origination volume was predominantly offset by an
increase in reserves related to the repurchase of
previously sold loans and markdowns of the mortgage
warehouse. Net mortgage servicing revenue (which
includes loan servicing revenue, MSR risk
management results and other changes in fair value)
was $2.7 billion, an increase of $1.5 billion, or
124%, from the prior year. Loan servicing revenue
was $3.3 billion, an increase of $924 million.
Third-party loans serviced increased 91%, primarily
due to the Washington Mutual transaction. MSR risk
management results were $1.5 billion, compared with
$411 million in the prior year. Other changes in
fair value of the MSR asset were negative $2.1
billion, compared with negative $1.5 billion in the
prior year.
The provision for credit losses was $9.5 billion,
compared with $2.5 billion in the prior year. The
provision reflected weakness in the home equity and
mortgage portfolios (see Retail Financial Services
discussion of the provision for credit losses for
further detail).
Noninterest expense was $4.8 billion, up $1.1
billion, or 30%, from the prior year, reflecting
higher mortgage reinsurance losses, the impact of
the Washington Mutual transaction and higher
servicing expense due to increased delinquencies
and defaults.
2007 compared with 2006
Consumer Lending net income was $680 million, a
decrease of $611 million, or 47%, from the prior
year. Total net revenue was $7.3 billion, up $1.5
billion, or 25%, benefiting from positive MSR risk
management results, increased mortgage production
revenue, wider loan spreads and the absence of a
prior-year $233 million loss related to $13.3
billion of mortgage loans transferred to
held-for-sale. These benefits were offset partially
by the sale of the insurance business.
Mortgage production revenue was $880 million, up
$576 million, reflecting the impact of an increase
in mortgage loan originations and the
classification of certain loan origination costs as
expense (loan origination costs previously netted
against revenue commenced being recorded as an
expense in the first quarter of 2007 due to the
adoption of SFAS 159).These benefits were offset
partially by markdowns of $241 million on the
mortgage warehouse and pipeline. Net mortgage
servicing revenue, which includes loan servicing
revenue, MSR risk management results and other
changes in fair value, was $1.2 billion, compared
with $314 million in the prior year. Loan servicing
revenue of $2.3 billion increased $195 million on
17% growth in third-party loans serviced. MSR risk
management results were positive $411 million
compared with negative $385 million in the prior
year. Other changes in fair value of the MSR asset
were negative $1.5 billion, compared with negative
$1.4 billion in the prior year.
The provision for credit losses was $2.5 billion,
compared with $447 million in the prior year. The
increase in the provision was due to the home
equity and subprime mortgage portfolios (see Retail
Financial Services discussion of the provision for
credit losses for further detail).
Noninterest expense was $3.7 billion, an increase
of $479 million, or 15%. The increase reflected the
classification of certain loan origination costs
due to the adoption of SFAS 159; higher servicing
costs due to increased delinquencies and defaults;
higher production expense due to growth in
originations; and increased depreciation expense on
owned automobiles subject to operating leases.
These increases were offset partially by the sale
of the insurance business.
Purchased credit-impaired loans represent loans acquired in the Washington Mutual
transaction that are accounted for under SOP 03-3.
(b)
Total average loans owned includes loans held-for-sale of $2.8 billion, $10.6 billion and
$16.1 billion for the years ended December 31, 2008, 2007 and 2006, respectively.
Credit data and quality statistics
(in millions, except ratios)
2008
2007
2006
Net charge-offs excluding
purchased credit-impaired(a)
Home equity
$
2,391
$
564
$
143
Prime mortgage
526
33
9
Subprime mortgage
933
157
47
Option ARMs
—
—
—
Auto loans
568
354
238
Other
113
79
25
Total net
charge-offs
$
4,531
1,187
462
Net charge-off rate excluding
purchased credit-impaired(a)
Home equity
2.39
%
0.62
%
0.18
%
Prime mortgage
1.18
0.13
0.03
Subprime mortgage
6.10
1.55
0.34
Option ARMs
—
—
—
Auto loans
1.30
0.86
0.56
Other
0.93
0.88
0.31
Total net charge-off rate
excluding purchased
credit-impaired(b)
2.08
0.67
0.27
Net charge-off rate – reported
Home equity
2.23
%
0.62
%
0.18
%
Prime mortgage
1.05
0.13
0.03
Subprime mortgage
5.49
1.55
0.34
Option ARMs
—
—
—
Auto loans
1.30
0.86
0.56
Other
0.93
0.88
0.31
Total net charge-off rate(b)
1.89
0.67
0.27
30+ day
delinquency rate excluding purchased credit-impaired(c)(d)(e)
4.21
%
3.10
%
1.80
%
Nonperforming assets(f)(g)(h)
$
8,653
$
3,084
$
1,658
Allowance for loan losses to
ending loans
2.36
%
1.24
%
0.64
%
Allowance for loan losses to
ending loans excluding purchased
credit-impaired loans(a)
3.16
1.24
0.64
(a)
Excludes the impact of purchased credit-impaired loans accounted for under SOP
03-3 that were acquired as part of the Washington Mutual transaction. Under SOP
03-3, these loans were accounted for at fair value on the acquisition date, which
includes the impact of estimated credit losses over the remaining lives of the loans.
Accordingly, no charge-offs and no allowance for loan losses has been recorded for
these loans.
(b)
Average loans included loans held-for-sale of $2.8 billion, $10.6 billion and $16.1
billion for the years ended December 31, 2008, 2007 and 2006, respectively. These
amounts were excluded when calculating the net charge-off rate.
(c)
Excluded loans eligible for repurchase as well as loans repurchased from GNMA
pools that are insured by U.S. government agencies of $3.2 billion, $1.2 billion and
$960 million, at December 31, 2008 ,2007 and 2006,
respectively. These amounts
were excluded, as reimbursement is proceeding normally.
(d)
Excluded loans that are 30 days past due and still accruing, which are insured by
U.S. government agencies under the Federal Family Education Loan Program of
$824 million, $663 million and $464 million at December 31, 2008, 2007 and
2006, respectively. These amounts are excluded as reimbursement is proceeding
normally.
(e)
Excludes purchased credit-impaired loans. The 30+
day delinquency rate for these loans was 17.89% at December 31,2008. There were no purchased credit-impaired loans at
December 31, 2007 and 2006.
(f)
Nonperforming assets excluded (1) loans eligible for repurchase as well as loans
repurchased from Governmental National Mortgage Association (“GNMA”) pools
that are insured by U.S. government agencies of $3.3 billion, $1.5 billion and $1.2
billion at December 31, 2008, 2007 and 2006, respectively, and (2) student loans
that are 90 days past due and still accruing, which are insured by U.S. government
agencies under the Federal Family Education Loan Program of $437 million, $417
million and $387 million at December 31, 2008, 2007 and 2006, respectively. These
amounts for GNMA and student loans are excluded, as reimbursement is proceeding normally.
(g)
During the second quarter of 2008, the policy for classifying subprime mortgage
and home equity loans as nonperforming was changed to conform to all other
home lending products. Amounts for 2007 have been revised to reflect
this change. Amounts for 2006 have not been revised as the impact was not material.
(h)
Excludes purchased credit-impaired loans accounted for under SOP 03-3 that were
acquired as part of the Washington Mutual transaction. These loans are accounted
for on a pool basis, and the pools are considered to be performing under SOP 03-3.
Avg. mortgage loans held-for-sale
and loans at fair value(a)
14.6
18.8
12.9
Average assets
278.1
216.1
211.1
Third-party mortgage loans serviced
(ending)
1,172.6
614.7
526.7
MSR net carrying value (ending)
9.3
8.6
7.5
Supplemental mortgage fees and
related income details (in millions)
Production revenue
$
898
$
880
$
304
Net mortgage servicing revenue:
Loan servicing revenue
3,258
2,334
2,139
Changes in MSR asset fair value:
Due to inputs or assumptions
in model
(6,849
)
(516
)
165
Other changes in fair value
(2,052
)
(1,531
)
(1,440
)
Total changes in MSR asset
fair value
(8,901
)
(2,047
)
(1,275
)
Derivative valuation adjustments
and other
8,366
927
(550
)
Total net mortgage servicing
revenue
2,723
1,214
314
Mortgage fees and related income
3,621
2,094
618
(a)
Included $14.2 billion and $11.9 billion
of prime mortgage loans at fair value for the
years ended December 31, 2008 and 2007,
respectively.
Mortgage origination channels comprise the following:
Retail – Borrowers who are buying or refinancing a home
through direct contact with a mortgage banker employed by the
Firm using a branch office, the Internet or by phone. Borrowers
are frequently referred to a mortgage banker by real estate brokers, home builders or other third parties.
Wholesale – A third-party mortgage
broker refers loan applications to a mortgage banker at the Firm. Brokers are independent
loan originators that specialize in finding and counseling borrowers
but do not provide funding for loans.
Correspondent – Banks, thrifts, other mortgage banks and
other financial institutions that sell closed loans to the Firm.
Correspondent negotiated transactions
(“CNT”) – Mid-to
large-sized mortgage lenders, banks and bank-owned companies
that sell loans or servicing to the Firm on an as-originated basis,
excluding bulk servicing transactions.
Production revenue –
Includes net gains or losses on originations and sales of prime and subprime mortgage loans and other
production-related fees.
Net
mortgage servicing revenue components: Servicing
revenue – Represents all gross income earned from servicing
third-party mortgage loans, including stated service fees, excess
service fees, late fees and other ancillary fees.
Changes in MSR asset fair value due to inputs or
assumptions in model – Represents MSR asset fair value
adjustments due to changes in market-based inputs, such as
interest rates and volatility, as well as updates to valuation
assumptions used in the valuation model.
Changes
in MSR asset fair value due to other changes –
Includes changes in the MSR value due to modeled servicing
portfolio runoff (or time decay).
Derivative valuation adjustments and
other – Changes in
the fair value of derivative instruments used to offset the impact
of changes in market-based inputs to the MSR valuation model.
MSR
risk management results – Includes changes in MSR
asset fair value due to inputs or assumptions and derivative valuation adjustments and other.
Chase Card Services is one of the nation’s largest card
issuers with more than 168 million credit cards in circulation and more than $190 billion in
managed loans.
Customers used Chase cards to meet more than $368
billion worth of their spending needs in 2008. Chase has
a market leadership position in building loyalty and
rewards programs with many of the world’s most
respected brands and through its proprietary products,
which include the Chase Freedom program.
Through its merchant acquiring business, Chase
Paymentech Solutions, Chase is one of the leading
processors of MasterCard and Visa payments.
JPMorgan Chase uses the concept of “managed basis” to evaluate
the credit performance of its credit card loans, both loans on the balance sheet and loans that
have been securitized. For further information, see Explanation and reconciliation of the Firm’s
use of non-GAAP financial measures on pages 38–39 of this Annual Report.
Managed results exclude the impact of credit card securitizations on
total net revenue, the provision for credit losses, net charge-offs and
loan receivables. Securitization does not change reported net income;
however, it does affect the classification of items on the Consolidated
Statements of Income and Consolidated Balance Sheets.
The following discussion of CS’ financial results reflects the acquisition of Washington Mutual’s
credit card operations, including $28.3
billion of managed credit card loans, as a result of the Washington Mutual transaction on September 25, 2008, and
the dissolution of the Chase
Paymentech Solutions joint venture on November 1, 2008. See Note
2 on pages 123–128 of this Annual Report for more information
concerning these transactions.
Selected income statement data – managed basis
Year ended December 31,
(in millions, except ratios)
2008
2007
2006
Revenue
Credit card income
$
2,768
$
2,685
$
2,587
All other income
(49
)
361
357
Noninterest revenue
2,719
3,046
2,944
Net interest income
13,755
12,189
11,801
Total net revenue
16,474
15,235
14,745
Provision for credit losses
10,059
5,711
4,598
Noninterest expense
Compensation expense
1,127
1,021
1,003
Noncompensation expense
3,356
3,173
3,344
Amortization of intangibles
657
720
739
Total noninterest expense
5,140
4,914
5,086
Income before income tax
expense
1,275
4,610
5,061
Income tax expense
495
1,691
1,855
Net income
$
780
$
2,919
$
3,206
Memo: Net securitization
gains (amortization)
$
(183
)
$
67
$
82
Financial ratios
ROE
5
%
21
%
23
%
Overhead ratio
31
32
34
2008 compared with 2007
Net income was $780 million, a decline of $2.1
billion, or 73%, from the prior year. The decrease
was driven by a higher provision for credit losses,
partially offset by higher total net revenue.
Average managed loans were $162.9 billion, an
increase of $13.5 billion, or 9%, from the prior
year. Excluding Washington Mutual, average managed
loans were $155.9 billion. End-of-period managed
loans were $190.3 billion, an increase of $33.3
billion, or 21%, from the prior year. Excluding
Washington Mutual, end-of-period managed loans were
$162.1 billion. The increases in both average
managed loans and end-of-period managed loans were
predominantly due to the impact of the Washington
Mutual transaction and organic portfolio growth.
Managed total net revenue was $16.5 billion, an
increase of $1.2 billion, or 8%, from the prior
year. Net interest income was $13.8 billion, up
$1.6 billion, or 13%, from the prior year, driven
by the Washington Mutual transaction, higher
average managed loan balances, and wider loan
spreads. These benefits were offset partially by
the effect of higher revenue reversals associated
with higher charge-offs. Noninterest revenue was
$2.7 billion, a decrease of $327 million, or 11%,
from the prior year, driven by increased rewards
expense, lower securitization income driven by
higher credit losses, and higher volume-driven
payments to partners; these were largely offset by
increased interchange income, benefiting from a 4%
increase in charge volume, as well as the impact of
the Washington Mutual transaction.
The managed provision for credit losses was $10.1
billion, an increase of $4.3 billion, or 76%, from
the prior year, due to an increase of $1.7 billion
in the allowance for loan losses and a higher level
of charge-offs. The managed net charge-off rate
increased to
5.01%, up from 3.68% in the prior year. The 30-day
managed delinquency rate was 4.97%, up from 3.48%
in the prior year. Excluding Washington Mutual, the
managed net charge-off rate was 4.92% and the
30-day delinquency rate was 4.36%.
Noninterest expense was $5.1 billion, an increase
of $226 million, or 5%, from the prior year,
predominantly due to the impact of the Washington
Mutual transaction.
2007 compared with 2006
Net income of $2.9 billion was down $287 million,
or 9%, from the prior year. Prior-year results
benefited from significantly lower net charge-offs
following the
change in bankruptcy legislation in the fourth
quarter of 2005. The increase in net charge-offs
was offset partially by higher revenue.
End-of-period managed loans of $157.1 billion
increased $4.2 billion, or 3%, from the prior year.
Average managed loans of $149.3 billion increased
$8.2 billion, or 6%, from the prior year. The
increases in both end-of-period and average managed
loans resulted from organic growth.
Managed total net revenue was $15.2 billion, an
increase of $490 million, or 3%, from the prior
year. Net interest income was $12.2 billion, up
$388 million, or 3%, from the prior year. The
increase in net interest income was driven by a
higher level of fees and higher average loan
balances. These benefits were offset partially by
narrower loan spreads, the discontinuation of
certain billing practices (including the
elimination of certain over-limit fees and the
two-cycle billing method for calculating finance
charges beginning in the second quarter of 2007)
and the effect of higher revenue reversals
associated
with higher charge-offs. Noninterest
revenue was $3.0 billion, an increase of $102
million, or 3%, from the prior year. The increase
reflected a higher level of fee-based revenue and
increased net interchange income, which benefited
from higher charge volume. Charge volume growth was
4%, reflecting a 9% increase in sales volume,
offset primarily by a lower level of balance
transfers, the result of more targeted marketing
efforts.
The managed provision for credit losses was $5.7
billion, an increase of $1.1 billion, or 24%, from
the prior year. The increase was primarily due to a
higher level of net charge-offs (the prior year
benefited from the change in bankruptcy legislation
in the fourth quarter of 2005) and an increase in
the allowance for loan losses, driven by higher
estimated net charge-offs in the portfolio. The
managed net charge-off rate was 3.68%, up from
3.33% in the prior year. The 30-day managed
delinquency rate was 3.48%, up from 3.13% in the
prior year.
Noninterest expense was $4.9 billion, a decrease of
$172 million, or 3%, compared with the prior year,
primarily due to lower marketing expense and lower
fraud-related expense, partially offset by higher
volume-related expense.
The following are brief descriptions of selected business metrics within Card Services.
•
Charge volume – Represents the dollar amount of cardmember purchases, balance transfers and cash
advance activity.
•
Net accounts opened – Includes originations, purchases and sales.
•
Merchant acquiring business – Represents a business that processes bank card transactions for
merchants.
–Bank card volume – Represents the dollar amount of transactions processed for merchants.
–Total transactions – Represents the number of transactions and authorizations processed for
merchants.
Number of registered Internet
customers (in millions)
35.6
28.3
22.5
Merchant acquiring business(d)
Bank card volume (in billions)
$
713.9
$
719.1
$
660.6
Total transactions (in billions)
21.4
19.7
18.2
Selected balance sheet data
(period-end)
Loans:
Loans on balance sheets
$
104,746
$
84,352
$
85,881
Securitized loans
85,571
72,701
66,950
Managed loans
$
190,317
$
157,053
$
152,831
Equity
$
15,000
$
14,100
$
14,100
Selected balance sheet data
(average)
Managed assets
$
173,711
$
155,957
$
148,153
Loans:
Loans on balance sheets
$
83,293
$
79,980
$
73,740
Securitized loans
79,566
69,338
67,367
Managed average loans
$
162,859
$
149,318
$
141,107
Equity
$
14,326
$
14,100
$
14,100
Headcount
24,025
18,554
18,639
Managed credit quality
statistics
Net charge-offs
$
8,159
$
5,496
$
4,698
Net charge-off rate(e)
5.01
%
3.68
%
3.33
%
Managed delinquency ratios
30+ day(e)
4.97
%
3.48
%
3.13
%
90+ day(e)
2.34
1.65
1.50
Allowance for loan losses(f)(i)
$
7,692
$
3,407
$
3,176
Allowance for loan losses to
period-end
loans(f)
7.34
%
4.04
%
3.70
%
Key stats – Washington Mutual only(g)
Managed loans
$
28,250
Managed average loans
6,964
Net interest income(h)
14.87
%
Risk adjusted margin(a)(h)
4.18
Net charge-off rate(e)
7.11
30+ day delinquency rate(e)
8.50
90+ day delinquency rate(e)
3.75
Year ended December 31,
(in millions, except headcount, ratios
and where otherwise noted)
2008
2007
2006
Key stats – excluding Washington Mutual
Managed loans
$
162,067
$
157,053
$
152,831
Managed average loans
155,895
149,318
141,107
Net interest income(h)
8.16
%
8.16
%
8.36
%
Risk adjusted margin(a)(h)
3.93
6.38
7.19
Net charge-off rate
4.92
3.68
3.33
30+ day delinquency rate
4.36
3.48
3.13
90+ day delinquency rate
2.09
1.65
1.50
(a)
Represents total net revenue
less provision for credit losses.
(b)
Pretax return on average managed
outstandings.
(c)
Results for 2008 included approximately 13
million credit card accounts acquired in the
Washington Mutual transaction. Results for 2006
included approximately 30 million accounts from
loan portfolio acquisitions.
(d)
The Chase Paymentech Solutions joint venture
was dissolved effective November 1, 2008. For the
period January 1, 2008 through October 31, 2008,
the data presented represent activity for the
Chase Paymentech Solutions joint venture and for
the period November 1, 2008 through December 31,2008, the data presented represent activity for
Chase Paymentech Solutions.
(e)
Results for 2008 reflect the impact of
purchase accounting adjustments related to the
Washington Mutual transaction.
(f)
Based on loans on a reported basis.
(g)
Statistics are only presented for periods
after September 25, 2008, the date of the
Washington Mutual transaction.
(h)
As a percentage of average managed outstandings.
(i)
The 2008 allowance for loan losses included an
amount related to loans acquired in the Washington
Mutual transaction.
The financial information presented below
reconciles reported basis and managed basis to
disclose the effect of securitizations.
Year ended December 31,
(in millions)
2008
2007
2006
Income statement data(a)
Credit card income
Reported
$
6,082
$
5,940
$
6,096
Securitization adjustments
(3,314
)
(3,255
)
(3,509
)
Managed credit card income
$
2,768
$
2,685
$
2,587
Net interest income
Reported
$
6,838
$
6,554
$
6,082
Securitization adjustments
6,917
5,635
5,719
Managed net interest income
$
13,755
$
12,189
$
11,801
Total net revenue
Reported
$
12,871
$
12,855
$
12,535
Securitization adjustments
3,603
2,380
2,210
Managed total net revenue
$
16,474
$
15,235
$
14,745
Provision for credit losses
Reported
$
6,456
$
3,331
$
2,388
Securitization adjustments
3,603
2,380
2,210
Managed provision for
credit losses
$
10,059
$
5,711
$
4,598
Balance sheet – average
balances(a)
Total average assets
Reported
$
96,807
$
89,177
$
82,887
Securitization adjustments
76,904
66,780
65,266
Managed average assets
$
173,711
$
155,957
$
148,153
Credit quality statistics(a)
Net charge-offs
Reported
$
4,556
$
3,116
$
2,488
Securitization adjustments
3,603
2,380
2,210
Managed net charge-offs
$
8,159
$
5,496
$
4,698
(a)
For a discussion of managed basis, see the non-GAAP financial measures discussion on pages
38–39 of this Annual Report.
Commercial Banking serves more than 26,000
clients nationally, including corporations,
municipalities, financial institutions and
not-for-profit entities with annual revenue
generally ranging from $10 million to $2
billion, and nearly 30,000 real estate
investors/owners.
Delivering extensive industry knowledge, local
expertise and dedicated service, CB partners
with the Firm’s other businesses to provide
comprehensive solutions, including lending,
treasury services, investment banking and asset
management, to meet its clients’ domestic and
international financial needs.
On September 25, 2008, JPMorgan Chase acquired the
banking operations of Washington Mutual from the
FDIC, adding approximately $44.5 billion in loans
to the Commercial Term Lending, Real Estate
Banking and Other businesses in Commercial
Banking. On October 1, 2006, JPMorgan Chase
completed the acquisition of The Bank of New
York’s consumer, business banking and
middle-market banking businesses, adding
approximately $2.3 billion in loans and
$1.2 billion in deposits in Commercial Banking.
Selected income statement data
Year ended December 31,
(in millions, except ratios)
2008
2007
2006
Revenue
Lending & deposit-related fees
$
854
$
647
$
589
Asset management, administration
and commissions
113
92
67
All other income(a)
514
524
417
Noninterest revenue
1,481
1,263
1,073
Net interest income
3,296
2,840
2,727
Total net revenue
4,777
4,103
3,800
Provision for credit losses
464
279
160
Noninterest expense
Compensation expense
692
706
740
Noncompensation expense
1,206
1,197
1,179
Amortization of intangibles
48
55
60
Total noninterest expense
1,946
1,958
1,979
Income before income tax expense
2,367
1,866
1,661
Income tax expense
928
732
651
Net income
$
1,439
$
1,134
$
1,010
Financial ratios
ROE
20
%
17
%
18
%
Overhead ratio
41
48
52
(a)
Revenue from investment banking products sold to CB clients and commercial card
revenue is included in all other income.
2008 compared with 2007
Net income was $1.4 billion, an increase of $305
million, or 27%, from the prior year, due to
growth in total net revenue including the impact
of the Washington Mutual transaction, partially
offset by a higher provision for credit losses.
Record total net revenue of $4.8 billion increased
$674 million, or 16%. Net interest income of $3.3
billion increased $456 million, or 16%, driven by
double-digit growth in liability and loan balances
and the impact of the Washington Mutual
transaction, partially offset by spread compression
in the liability and loan portfolios. Noninterest
revenue was $1.5 billion, up $218 million, or 17%,
due to higher deposit and lending-related fees.
On a client segment basis, Middle Market Banking
revenue was $2.9 billion, an increase of $250
million, or 9%, from the prior year due
predominantly to higher deposit-related fees and
growth in liability and loan balances. Revenue from
Commercial Term Lending, a new client segment
established as a result of the Washington Mutual
transaction encompassing multi-family and
commercial mortgage loans, was $243 million.
Mid-Corporate Banking revenue was $921 million, an
increase of $106 million, or 13%, reflecting higher
loan balances, investment banking revenue, and
deposit-related fees. Real Estate Banking revenue
of $413 million decreased $8 million, or 2%.
Provision for credit losses was $464 million, an
increase of $185 million, or 66%, compared with the
prior year, reflecting a weakening credit
environment and loan growth. Net charge-offs were
$288 million (0.35% net charge-off rate), compared
with $44 million (0.07% net charge-off rate) in the
prior year, predominantly related to an increase in
real estate charge-offs. The allowance for loan
losses increased $1.1 billion, which primarily
reflected the impact of the Washington Mutual
transaction. Nonperforming assets were $1.1
billion, an increase of $1.0 billion compared with
the prior year, predominantly reflecting the
Washington Mutual transaction and higher real
estate-related balances.
Noninterest expense was $1.9 billion, a decrease of
$12 million, or 1%, from the prior year, due to
lower performance-based incentive compensation and
volume-based charges from service providers,
predominantly offset by the impact of the
Washington Mutual transaction.
2007 compared with 2006
Net income was $1.1 billion, an increase of $124
million, or 12%, from the prior year due primarily
to growth in total net revenue, partially offset by
higher provision for credit losses.
Record total net revenue of $4.1 billion increased $303 million, or
8%. Net interest income of $2.8 billion increased
$113 million, or 4%, driven by double-digit growth
in liability balances and loans, which reflected
organic growth and the Bank of New York
transaction, largely offset by the continued shift
to narrower-spread liability products and spread
compression in the loan and liability portfolios.
Noninterest revenue was $1.3 billion, up $190
million, or 18%, due to increased deposit-related
fees, higher investment banking revenue, and gains
on sales of securities acquired in the satisfaction
of debt.
On a segment basis, Middle Market Banking revenue
was $2.7 billion, an increase of $154 million, or
6%, primarily due to the Bank of New York
transaction, higher deposit-related fees and growth
in investment banking revenue. Mid-Corporate
Banking revenue was $815 million, an increase of
$159 million, or 24%, reflecting higher
lending revenue, investment banking revenue,
and gains on sales of securities acquired in the
satisfaction of debt. Real Estate Banking revenue
of $421 million decreased $37 million, or 8%.
Provision for credit losses was $279 million,
compared with $160 million in the prior year. The
increase in the allowance for credit losses
reflected portfolio activity including slightly
lower credit quality as well as growth in loan
balances. The allowance for loan losses to average
loans retained was 2.81%, compared with 2.86% in
the prior year.
Noninterest expense was $2.0 billion, a decrease
of $21 million, or 1%, largely due to lower
compensation expense driven by the absence of
prior-year expense from the adoption of SFAS 123R,
partially offset by expense growth related to the
Bank of New York transaction.
Selected metrics
Year ended December 31,
(in millions, except
headcount)
2008
2007
2006
Revenue by product:
Lending
$
1,743
$
1,419
$
1,344
Treasury services
2,648
2,350
2,243
Investment banking
334
292
253
Other
52
42
(40
)
Total Commercial Banking
revenue
$
4,777
$
4,103
$
3,800
IB revenue, gross(a)
$
966
$
888
$
716
Revenue by business:
Middle Market Banking
$
2,939
$
2,689
$
2,535
Commercial Term Lending(b)
243
—
—
Mid-Corporate Banking
921
815
656
Real Estate Banking(b)
413
421
458
Other(b)
261
178
151
Total Commercial Banking
revenue
$
4,777
$
4,103
$
3,800
Selected balance sheet data
(period-end)
Equity
$
8,000
$
6,700
$
6,300
Selected balance sheet data
(average)
Total assets
$
114,299
$
87,140
$
57,754
Loans:
Loans retained
81,931
60,231
53,154
Loans held-for-sale and loans at
fair value
406
863
442
Total loans
$
82,337
$
61,094
$
53,596
Liability balances(c)
103,121
87,726
73,613
Equity
$
7,251
$
6,502
$
5,702
Average loans by business:
Middle Market Banking
$
42,193
$
37,333
$
33,225
Commercial Term Lending(b)
9,310
—
—
Mid-Corporate Banking
16,297
12,481
8,632
Real Estate Banking(b)
9,008
7,116
7,566
Other(b)
5,529
4,164
4,173
Total Commercial Banking
loans
$
82,337
$
61,094
$
53,596
Headcount
5,206
4,125
4,459
Year ended December 31,
(in millions, except ratios)
2008
2007
2006
Credit data and quality
statistics:
Net charge-offs
$
288
$
44
$
27
Nonperforming loans(d)
1,026
146
121
Nonperforming assets
1,142
148
122
Allowance for credit losses:
Allowance for loan losses(e)
2,826
1,695
1,519
Allowance for lending-related
commitments
206
236
187
Total allowance for credit losses
3,032
1,931
1,706
Net charge-off rate(f)
0.35
%
0.07
%
0.05
%
Allowance for loan losses to average loans(d)(f)
3.04
(g)
2.81
2.86
Allowance for loan losses to
nonperforming
loans(d)
275
1,161
1,255
Nonperforming loans to average loans(d)
1.10
(g)
0.24
0.23
(a)
Represents the total revenue related to investment banking products sold to CB
clients.
(b)
Results for 2008 include total net revenue and average loans acquired in the
Washington Mutual transaction.
(c)
Liability balances include deposits and deposits swept to on-balance sheet
liabilities such as commercial paper, federal funds purchased and securities loaned or
sold under repurchase agreements.
(d)
Purchased credit-impaired wholesale loans accounted for under SOP 03-3 that were
acquired in the Washington Mutual transaction are considered nonperforming loans because
the timing and amount of expected cash flows are not reasonably estimable.
These nonperforming loans were included when calculating the allowance coverage ratio, the
allowance for loan losses to nonperforming loans ratio, and the nonperforming loans to
average loans ratio. The carrying amount of these purchased credit- impaired loans was $224
million at December 31, 2008.
(e)
Beginning in 2008, the allowance for loan losses included an amount related to
loans acquired in the Washington Mutual transaction and the Bear Stearns merger.
(f)
Loans held-for-sale and loans accounted for at fair value were excluded when
calculating the allowance coverage ratio and the net charge-off rate.
(g)
The September 30, 2008, ending loan balance of $44.5 billion
acquired in the Washington Mutual transaction is treated as if it had
been part of the loan balance for the entire third quarter of 2008.
TSS is a global leader in transaction, investment and information services. TSS is one of the
world’s largest cash management providers and a leading global custodian. TS provides cash
management, trade, wholesale card and liquidity products and services to small and mid-sized
companies, multinational corporations, financial institutions and government entities. TS partners
with the Commercial Banking, Retail Financial Services and Asset Management businesses to serve
clients firmwide. As a result, certain TS revenue is included in other segments’ results. WSS
holds, values, clears and services securities, cash and alternative investments for investors and
broker-dealers, and manages depositary receipt programs globally.
As a result of the transaction with the Bank of New York on October1, 2006, selected corporate trust businesses were transferred from TSS to the Corporate/Private
Equity segment and are reported in discontinued operations.
Selected income statement data
Year ended December 31,
(in millions, except ratio data)
2008
2007
2006
Revenue
Lending & deposit-related fees
$
1,146
$
923
$
735
Asset management, administration
and commissions
3,133
3,050
2,692
All other income
917
708
612
Noninterest revenue
5,196
4,681
4,039
Net interest income
2,938
2,264
2,070
Total net revenue
8,134
6,945
6,109
Provision for credit losses
82
19
(1
)
Credit reimbursement to IB(a)
(121
)
(121
)
(121
)
Noninterest expense
Compensation expense
2,602
2,353
2,198
Noncompensation expense
2,556
2,161
1,995
Amortization of intangibles
65
66
73
Total noninterest expense
5,223
4,580
4,266
Income before income tax
expense
2,708
2,225
1,723
Income tax expense
941
828
633
Net income
$
1,767
$
1,397
$
1,090
Revenue by business
Treasury Services
$
3,555
$
3,013
$
2,792
Worldwide Securities Services
4,579
3,932
3,317
Total net revenue
$
8,134
$
6,945
$
6,109
Financial ratios
ROE
47
%
47
%
48
%
Overhead ratio
64
66
70
Pretax margin ratio(b)
33
32
28
Year ended December 31,
(in millions, except headcount)
2008
2007
2006
Selected balance sheet data
(period-end)
Equity
$
4,500
$
3,000
$
2,200
Selected balance sheet data
(average)
Total assets
$
54,563
$
53,350
$
31,760
Loans(c)
26,226
20,821
15,564
Liability balances(d)
279,833
228,925
189,540
Equity
3,751
3,000
2,285
Headcount
27,070
25,669
25,423
(a)
TSS is charged a credit reimbursement related to certain exposures managed within IB
credit portfolio on behalf of clients shared with TSS. Beginning in first quarter 2009, income
statement and balance sheet items for credit portfolio activity related to joint IB/TSS
clients will be reflected proportionally in the respective IB and TSS financials. This will
replace the previous approach whereby a credit reimbursement was charged to TSS by IB.
(b)
Pretax margin represents income before income tax expense divided by total net
revenue, which is a measure of pretax performance and another basis by which management
evaluates its performance and that of its competitors.
(c)
Loan balances include wholesale overdrafts, commercial card and trade finance loans.
(d)
Liability balances include deposits and deposits swept to on-balance sheet liabilities
such as commercial paper, federal funds purchased and securities loaned or sold under
repurchase agreements.
2008 compared with 2007
Net income was a record $1.8 billion, an increase of $370 million, or 26%, from the prior year,
driven by higher total net revenue. This increase was largely offset by higher noninterest expense.
Total net revenue was a record $8.1 billion, an increase of $1.2 billion, or 17%, from the prior
year. Worldwide Securities Services posted record net revenue of $4.6 billion, an increase of $647
million, or 16%, from the prior year. The growth was driven by wider spreads in securities lending,
foreign exchange and liability products, increased product usage by new and existing clients
(largely in custody, fund services, alternative investment services and depositary receipts) and
higher liability balances, reflecting increased client deposit activity resulting from recent
market conditions. These benefits were offset partially by market depreciation. Treasury Services
posted record net revenue of $3.6 billion, an increase of $542 million, or 18%, reflecting higher
liability balances and volume growth in electronic funds transfer products and trade loans. Revenue
growth from higher liability balances reflects increased client deposit activity resulting from
recent market conditions as well as organic growth. TSS firmwide net revenue, which includes
Treasury Services net revenue recorded in other lines of business, grew to $11.1 billion, an
increase of $1.5 billion, or 16%. Treasury Services firmwide net revenue grew to $6.5 billion, an
increase of $869 million, or 15%.
Noninterest expense was $5.2 billion, an increase of $643 million, or 14%, from the prior year,
reflecting higher expense related to business and volume growth as well as continued investment in
new product platforms.
2007 compared with 2006
Net income was a record $1.4 billion, an increase of $307 million, or 28%, from the prior year,
driven by record total net revenue, partially offset by higher noninterest expense.
Total net revenue was $6.9 billion, an increase of $836 million, or 14%, from the prior year.
Worldwide Securities Services net revenue of $3.9 billion was up $615 million, or 19%. The growth
was driven by increased product usage by new and existing clients (primarily custody, securities
lending, depositary receipts and fund services), market appreciation on assets under custody, and
wider spreads on securities lending. These gains were offset partially by spread compression on
liability products. Treasury Services net revenue was $3.0 billion, an increase of $221 million, or
8%, from the prior year. The results were driven by growth in electronic transaction volumes and
higher liability balances, offset partially by a shift to narrower-spread liability products. TSS
firmwide net revenue, which includes Treasury Services net revenue recorded in other lines of
business, grew to $9.6 billion, up
$1.0 billion, or 12%. Treasury Services firmwide net revenue grew to
$5.6 billion, up $391 million, or 7%.
Noninterest expense was $4.6 billion, an increase of $314 million, or 7%, from the prior year,
reflecting higher expense related to business and volume growth, as well as investment in new
product platforms.
Treasury & Securities Services firmwide metrics include revenue recorded in the CB, Retail Banking
and AM lines of business and excludes foreign exchange (“FX”) revenue recorded in IB for
TSS-related FX activity. In order to capture the firmwide impact of TS and TSS products and
revenue, management reviews firmwide metrics such as liability balances, revenue and overhead
ratios in assessing financial performance for TSS. Firmwide metrics are necessary in order to
understand the aggregate TSS business.
Selected metrics
Year ended December 31,
(in millions, except ratio data)
2008
2007
2006
TSS firmwide disclosures
Treasury Services revenue –
reported
$
3,555
$
3,013
$
2,792
Treasury Services revenue
reported in Commercial Banking
2,648
2,350
2,243
Treasury Services revenue
reported in other lines of business
International electronic funds transfer
volume (in thousands)(d)
171,036
168,605
145,325
Wholesale check volume
(in millions)
2,408
2,925
3,409
Wholesale cards issued
(in thousands)(e)
22,784
18,722
17,228
Credit data and quality
statistics
Net charge-offs (recoveries)
$
(2
)
$
—
$
1
Nonperforming loans
30
—
—
Allowance for loan losses
74
18
7
Allowance for lending-related
commitments
63
32
1
Net charge-off (recovery) rate
(0.01
)%
—
%
0.01
%
Allowance for loan losses to
average loans
0.28
0.09
0.04
Allowance for loan losses to
nonperforming loans
247
NM
NM
Nonperforming loans to average
loans
0.11
—
—
(a)
TSS firmwide FX revenue, which includes FX revenue recorded in TSS and FX revenue
associated with TSS customers who are FX customers of IB, was $880 million, $552 million and
$445 million for the years ended December 31, 2008, 2007 and 2006, respectively.
(b)
Firmwide liability balances include TS’ liability balances recorded in the Commercial
Banking line of business.
(c)
Overhead ratios have been calculated based upon firmwide revenue and TSS and TS
expense, respectively, including those allocated to certain other lines of business. FX
revenue and expense recorded in IB for TSS-related FX activity are not included in this ratio.
(d)
International electronic funds transfer includes non-U.S. dollar ACH and clearing
volume.
(e)
Wholesale cards issued include domestic commercial card, stored value card, prepaid
card and government electronic benefit card products.
AM, with assets under supervision of $1.5 trillion, is a global leader in investment and wealth
management. AM clients include institutions, retail investors and high-net-worth individuals in
every major market throughout the world. AM offers global investment management in equities, fixed
income, real estate, hedge funds, private equity and liquidity, including money market instruments
and bank deposits. AM also provides trust and estate, banking and brokerage services to
high-net-worth clients, and retirement services for corporations and individuals. The majority of
AM’s client assets are in actively managed portfolios.
On May 30, 2008, JPMorgan Chase merged with The Bear Stearns Companies, Inc. The merger resulted in
the addition of a new client segment, Bear Stearns Brokerage, but did not materially affect
balances or business metrics.
Selected income statement data
Year ended December 31,
(in millions, except ratios)
2008
2007
2006
Revenue
Asset management, administration
and commissions
$
6,004
$
6,821
$
5,295
All other income
62
654
521
Noninterest revenue
6,066
7,475
5,816
Net interest income
1,518
1,160
971
Total net revenue
7,584
8,635
6,787
Provision for credit losses
85
(18
)
(28
)
Noninterest expense
Compensation expense
3,216
3,521
2,777
Noncompensation expense
2,000
1,915
1,713
Amortization of intangibles
82
79
88
Total noninterest expense
5,298
5,515
4,578
Income before income tax
expense
2,201
3,138
2,237
Income tax expense
844
1,172
828
Net income
$
1,357
$
1,966
$
1,409
Revenue by client segment
Private Bank(a)
$
2,565
$
2,362
$
1,686
Institutional
1,775
2,525
1,972
Retail
1,620
2,408
1,885
Private Wealth Management(a)
1,387
1,340
1,244
Bear Stearns
Brokerage
237
—
—
Total net revenue
$
7,584
$
8,635
$
6,787
Financial ratios
ROE
24
%
51
%
40
%
Overhead ratio
70
64
67
Pretax margin ratio(b)
29
36
33
(a)
In 2008, certain clients were transferred from Private Bank to Private Wealth
Management. Prior periods have been revised to conform to this change.
(b)
Pretax margin represents income before income tax expense divided by total net
revenue, which is a measure of pretax performance and another basis by which management
evaluates its performance and that of its competitors.
2008 compared with 2007
Net income was $1.4 billion, a decline of $609 million, or 31%, from the prior year, driven by
lower total net revenue offset partially by lower noninterest expense.
Total net revenue was $7.6 billion, a decrease of $1.1 billion, or 12%, from the prior year.
Noninterest revenue was $6.1 billion, a decline of $1.4 billion, or 19%, due to lower performance
fees and the effect of lower markets, including the impact of lower market valuations of seed
capital investments. The lower results were offset partially by the benefit of the Bear Stearns
merger and increased revenue from net asset inflows. Net interest income was $1.5 billion, up $358
million, or 31%, from the prior year, due to higher deposit and loan balances and wider deposit
spreads.
Private Bank revenue grew 9% to $2.6 billion, due to increased deposit and loan balances and net
asset inflows, partially offset by the effect of lower markets and lower performance fees.
Institutional revenue declined 30% to $1.8 billion due to lower performance fees, partially offset
by net liquidity inflows. Retail revenue declined 33% to $1.6 billion due to the effect of lower
markets, including the impact of lower market valuations of seed capital investments and net equity
outflows. Private Wealth Management revenue grew 4% to $1.4 billion due to higher deposit and loan
balances. Bear Stearns Brokerage contributed $237 million to revenue.
The provision for credit losses was $85 million, compared with a benefit of $18 million in the
prior year, reflecting an increase in loan balances, higher net charge-offs and a weakening credit
environment.
Noninterest expense was $5.3 billion, down $217 million, or 4%, compared with the prior year due to
lower performance-based compensation, largely offset by the effect of the Bear Stearns merger and
higher compensation expense resulting from increased average headcount.
2007 compared with 2006
Net income was a record $2.0 billion, an increase of $557 million, or 40%, from the prior year.
Results benefited from record total net revenue, partially offset by higher noninterest expense.
Total net revenue was $8.6 billion, an increase of $1.8 billion, or 27%, from the prior year.
Noninterest revenue, primarily fees and commissions, was $7.5 billion, up $1.7 billion, or 29%,
largely due to increased assets under management and higher performance and placement fees. Net
interest income was $1.2 billion, up $189 million, or 19%, from the prior year, largely due to
higher deposit and loan balances.
Institutional revenue grew 28% to $2.5 billion, due to net asset inflows and performance fees.
Private Bank revenue grew 40% to
$2.4 billion, due to higher assets under management, performance and placement fees, and increased
loan and deposit balances. Retail revenue grew 28%, to $2.4 billion, primarily due to market
appreciation and net asset inflows. Private Wealth Management revenue
grew 8% to $1.3 billion, reflecting higher assets under management and higher deposit balances.
The provision for credit losses was a benefit of $18 million, compared with a benefit of $28
million in the prior year.
Noninterest expense was $5.5 billion, an increase of $937 million, or 20%, from the prior year. The
increase was due primarily to higher performance-based compensation expense and investments in all
business segments.
Selected metrics
Year ended December 31,
(in millions, except headcount, ranking
data, and where otherwise noted)
2008
2007
2006
Business metrics
Number of:
Client advisors
1,705
1,729
1,506
Retirement planning services
participants
1,531,000
1,501,000
1,362,000
Bear Stearns brokers
324
—
—
% of customer assets in 4 & 5 Star
Funds(a)
42
%
55
%
58
%
% of AUM in 1st and 2nd quartiles:(b)
1 year
54
%
57
%
83
%
3 years
65
%
75
%
77
%
5 years
76
%
76
%
79
%
Selected balance sheet data
(period-end)
Equity
$
7,000
$
4,000
$
3,500
Selected balance sheet data
(average)
Total assets
$
65,550
$
51,882
$
43,635
Loans(c)
38,124
29,496
26,507
Deposits
70,179
58,863
50,607
Equity
5,645
3,876
3,500
Headcount
15,339
14,799
13,298
Credit data and quality
statistics
Net charge-offs (recoveries)
$
11
$
(8
)
$
(19
)
Nonperforming loans
147
12
39
Allowance for loan losses
191
112
121
Allowance for lending-related
commitments
5
7
6
Net charge-off (recovery) rate
0.03
%
(0.03
)%
(0.07
)%
Allowance for loan losses to
average loans
0.50
0.38
0.46
Allowance for loan losses to
nonperforming loans
130
933
310
Nonperforming loans to average loans
0.39
0.04
0.15
(a)
Derived from following rating services: Morningstar for the United States; Micropal
for the United Kingdom, Luxembourg, Hong Kong and Taiwan; and Nomura for Japan.
(b)
Derived from following rating services: Lipper for the United States and Taiwan;
Micropal for the United Kingdom, Luxembourg and Hong Kong; and Nomura for Japan.
(c)
Reflects the transfer in 2007 of held-for-investment prime mortgage loans transferred
from AM to Corporate within the Corporate/Private Equity segment.
AM’s client segments comprise the following:
Institutional brings comprehensive global investment services –including asset management, pension
analytics, asset-liability management and active risk budgeting strategies – to corporate and
public institutions, endowments, foundations, not-for-profit organizations and governments
worldwide.
Retail provides worldwide investment management services and retirement planning and administration
through third-party and direct distribution of a full range of investment vehicles.
The Private Bank addresses every facet of wealth management for ultra-high-net-worth individuals
and families worldwide, including investment management, capital markets and risk management, tax
and estate planning, banking, capital raising and specialty-wealth advisory services.
Private Wealth Management offers high-net-worth individuals, families and business owners in the
United States comprehensive wealth management solutions, including investment management, capital
markets and risk management, tax and estate planning, banking and specialty-wealth advisory
services.
Bear Stearns Brokerage provides investment advice and wealth management services to high-net-worth
individuals, money managers, and small corporations.
J.P.
Morgan Asset Management has established two measures of its overall performance.
•
Percentage of assets under management in funds rated 4 and 5 stars (3 year). Mutual fund
rating services rank funds based on their risk-adjusted performance over various periods. A 5
star rating is the best and represents the top 10% of industry wide ranked funds. A 4 star
rating represents the next 22% of industry wide ranked funds. The worst rating is a 1 star
rating.
•
Percentage of assets under management in first- or second- quartile funds (one, three
and five years). Mutual fund rating services rank funds according to a peer-based performance
system, which measures returns according to specific time and fund classification (small, mid,
multi and large cap).
2008 compared with 2007
Assets under supervision (“AUS”) were $1.5 trillion, a decrease of $76 billion, or 5%, from the prior year.
Assets under management (“AUM”) were $1.1 trillion, down $60 billion, or 5%, from the prior year. The
decrease was due to the effect of lower markets and non-liquidity outflows, predominantly offset by
liquidity product inflows across all segments and the addition of Bear Stearns assets under
management. Custody, brokerage,
administration and deposit balances were $363 billion, down $16 billion due to the effect of lower
markets on brokerage and custody balances, offset by the addition of Bear Stearns Brokerage. The
Firm also has a 43% interest in American Century Companies, Inc., whose AUM totaled $70 billion and
$102 billion at December 31, 2008 and 2007, respectively, which are excluded from the AUM above.
2007 compared with 2006
AUS were $1.6 trillion, an increase of $225 billion, or 17%, from the
prior year. AUM were $1.2 trillion, up 18%, or $180 billion, from the
prior year. The increase in AUM was the result of net asset inflows into liquidity and alternative
products and market appreciation across all segments. Custody, brokerage, administration and
deposit balances were $379 billion, up $45 billion. The Firm also has a 44% interest in American
Century Companies, Inc., whose AUM totaled $102 billion and $103 billion at December 31, 2007 and
2006, respectively, which are excluded from the AUM above.
Assets under supervision(a)
As of or for the year
ended December 31, (in billions)
2008
2007
2006
Assets by asset class
Liquidity
$
613
$
400
$
311
Fixed income
180
200
175
Equities & balanced
240
472
427
Alternatives
100
121
100
Total assets under
management
1,133
1,193
1,013
Custody/brokerage/
administration/deposits
363
379
334
Total assets under supervision
$
1,496
$
1,572
$
1,347
Assets by client segment
Institutional
$
681
$
632
$
538
Private Bank(b)
181
183
142
Retail
194
300
259
Private Wealth Management(b)
71
78
74
Bear Stearns Brokerage
6
—
—
Total assets under management
$
1,133
$
1,193
$
1,013
Institutional
$
682
$
633
$
539
Private Bank(b)
378
403
328
Retail
262
394
343
Private Wealth Management(b)
124
142
137
Bear Stearns Brokerage
50
—
—
Total assets under supervision
$
1,496
$
1,572
$
1,347
Assets by geographic region
As of or for the year
ended December 31, (in billions)
2008
2007
2006
U.S./Canada
$
798
$
760
$
630
International
335
433
383
Total assets under management
$
1,133
$
1,193
$
1,013
U.S./Canada
$
1,084
$
1,032
$
889
International
412
540
458
Total assets under supervision
$
1,496
$
1,572
$
1,347
Mutual fund assets by asset class
Liquidity
$
553
$
339
$
255
Fixed income
41
46
46
Equities
99
224
206
Total mutual fund assets
$
693
$
609
$
507
Assets under management
rollforward
Beginning balance, January 1
$
1,193
$
1,013
$
847
Net asset flows:
Liquidity
210
78
44
Fixed income
(12
)
9
11
Equities, balanced and alternative
(47
)
28
34
Market/performance/other impacts(c)
(211
)
65
77
Ending balance, December 31
$
1,133
$
1,193
$
1,013
Assets under supervision
rollforward
Beginning balance, January 1
$
1,572
$
1,347
$
1,149
Net asset flows
181
143
102
Market/performance/other impacts(c)
(257
)
82
96
Ending balance, December 31
$
1,496
$
1,572
$
1,347
(a)
Excludes assets under management of American Century Companies, Inc., in which the
Firm had a 43%, 44% and 43% ownership at December 31, 2008, 2007 and 2006, respectively.
(b)
In 2008, certain clients were transferred from Private Bank to Private Wealth
Management. Prior periods have been revised to conform to this change.
(c)
Includes $15 billion for assets under management and $68 billion for assets under
supervision from the Bear Stearns merger in the second quarter of 2008.
The Corporate/Private Equity sector
comprises Private Equity, Treasury, corporate
staff units and expense that is centrally
managed. Treasury manages capital, liquidity,
interest rate and foreign exchange risk and the
investment portfolio for the Firm. The corporate
staff units include Central Technology and
Operations, Internal Audit, Executive Office,
Finance, Human Resources, Marketing &
Communications, Legal & Compliance, Corporate
Real Estate and General Services, Risk
Management, Corporate Responsibility and
Strategy & Development. Other centrally managed
expense includes the Firm’s occupancy and
pension-related expense, net of allocations to
the business.
Selected income statement data
Year ended December 31,
(in millions)
2008
2007
2006
Revenue
Principal transactions(a)(b)
$
(3,588
)
$
4,552
$
1,181
Securities gains (losses)(c)
1,637
39
(608
)
All other income(d)
1,673
465
485
Noninterest revenue
(278
)
5,056
1,058
Net interest income (expense)
347
(637
)
(1,044
)
Total net revenue
69
4,419
14
Provision for credit losses
447
(j)(k)
(11
)
(1
)
Provision for credit losses –
accounting conformity(e)
1,534
—
—
Noninterest expense
Compensation expense
2,340
2,754
2,626
Noncompensation expense(f)
1,841
3,025
2,357
Merger costs
432
209
305
Subtotal
4,613
5,988
5,288
Net expense allocated to other
businesses
(4,641
)
(4,231
)
(4,141
)
Total noninterest expense
(28
)
1,757
1,147
Income (loss) from continuing
operations before income
tax expense (benefit)
(1,884
)
2,673
(1,132
)
Income tax expense (benefit)(g)
(535
)
788
(1,179
)
Income (loss) from continuing
operations
(1,349
)
1,885
47
Income from discontinued
operations(h)
—
—
795
Income before extraordinary gain
(1,349
)
1,885
842
Extraordinary gain(i)
1,906
—
—
Net income
$
557
$
1,885
$
842
(a)
Included losses on preferred equity interests in Fannie Mae and Freddie Mac in
2008.
(b)
The Firm adopted SFAS 157 in the first quarter of 2007. See Note 4 on pages
129–143 of this Annual Report for additional information.
(c)
Included gain on sale of MasterCard shares in 2008.
(d)
Included a gain from the dissolution of the Chase Paymentech Solutions joint
venture and proceeds from the sale of Visa shares in its initial public offering in 2008.
(e)
Represents an accounting conformity loan loss reserve provision related to the
acquisition of Washington Mutual Bank’s banking operations. For a further discussion, see
Consumer Credit Portfolio on page 99 of this Annual Report.
(f)
Included a release of credit card litigation reserves in 2008 and insurance
recoveries related to settlement of the Enron and WorldCom class action litigations and
for certain other material legal proceedings of $512 million for full year 2006.
(g)
Includes tax benefits recognized upon resolution of tax audits.
(h)
Included a $622 million gain from the sale of selected corporate trust businesses
in 2006.
(i)
Effective September 25, 2008, JPMorgan Chase acquired Washington Mutual’s banking
operations from the FDIC for $1.9 billion. The fair value of the Washington Mutual net
assets acquired exceeded the purchase price, which resulted in negative goodwill. In
accordance with SFAS 141, nonfinancial assets that are not held-for-sale were written
down against that negative goodwill. The negative goodwill that remained after writing
down nonfinancial assets was recognized as an extraordinary gain in 2008.
(j)
In November 2008, the Firm transferred $5.8 billion of higher quality credit card
loans from the legacy Chase portfolio to a securitization trust previously established by
Washington Mutual (“the Trust”). As a result of converting higher credit quality
Chase-originated on-book receivables to the Trust’s seller’s interest which has a higher
overall loss rate reflective of the total assets within the Trust, approximately $400
million of incremental provision expense was recorded during the fourth quarter. This
incremental provision expense was recorded in the Corporate segment as the action related
to the acquisition of Washington Mutual’s banking operations. For further discussion of
credit card securitizations, see Note 16 on pages 169–170 of this Annual Report.
(k)
Includes $9 million for credit card securitizations related to the Washington
Mutual transaction.
2008 compared with 2007
Net income for Corporate/Private Equity was $557
million, compared with net income of $1.9 billion
in the prior year. This segment includes the
results of Private Equity and Corporate business
segments, as well as merger-related items.
Net loss for Private Equity was $690 million,
compared with net income of $2.2 billion in the
prior year. Net revenue was negative $963
million, a decrease of $4.9 billion, reflecting
Private Equity losses of $894 million, compared
with gains of $4.1 billion in the prior year.
Noninterest expense was negative $120 million, a
decrease of $469 million from the prior year,
reflecting lower compensation expense.
Net income for Corporate was $1.5 billion, compared
with a net loss of $150 million in the prior year.
Net revenue was $1.0 billion, an increase of $580
million. Excluding merger-related items, net
revenue was $1.7 billion, an increase of $1.2
billion. Net revenue included a gain of $1.5
billion on the proceeds from the sale of Visa
shares in its initial public offering, $1.0 billion
on the dissolution of the Chase Paymentech
Solutions joint venture, and $668 million from the
sale of MasterCard shares, partially offset by
losses of $1.1 billion on preferred securities of
Fannie Mae and Freddie Mac and $464 million related
to the offer to repurchase auction-rate securities.
2007 included a gain of $234 million on the sale of
MasterCard shares.
Noninterest expense was negative $736 million,
compared with $959 million in the prior year,
driven mainly by lower litigation expense.
Merger-related items were a net loss of $2.1
billion
compared with a net loss of $130 million in the
prior year. Washington Mutual merger-related items
included conforming loan loss reserve of $1.5
billion, credit card related loan loss reserves of
$403 million and net merger-related costs of $138
million. Bear Stearns merger-related included a net
loss of $423 million, which represented JPMorgan
Chase’s
49.4% ownership in Bear Stearns losses from April
8 to May 30, 2008, and net merger-related costs
of $665 million. 2007 included merger costs of
$209 million related to the Bank One and Bank of
New York transactions.
2007 compared with 2006
Net income was $1.9 billion, compared with $842
million in the prior year, benefiting from strong
Private Equity gains, partially offset by higher
expense. Prior-year results also included Income
from discontinued operations of $795 million, which
included a one-time gain of $622 million from the
sale of selected corporate trust businesses.
Net income for Private Equity was $2.2 billion,
compared with $627 million in the prior year.
Total net revenue was $4.0 billion, an increase of
$2.8 billion. The increase was driven by Private
Equity gains of $4.1 billion, compared with $1.3
billion, reflecting a higher level of gains and
the change in classification of carried interest
to compensation expense. Total noninterest expense
was $589 million, an increase of $422 million from
the prior year. The increase was driven by higher
compensation expense, reflecting the change in the
classification of carried interest.
Net loss for Corporate was $150 million, compared
with a net loss of $391 million in the prior year.
Corporate total net revenue was $452 million, an
increase of $1.6 billion. Revenue benefited from
net security gains compared with net security
losses in the prior year and improved net interest
spread. Total noninterest expense was $959 million,
an increase of $284 million from the prior year.
The increase reflected higher net litigation
expense, driven by credit card-related litigation
and the absence of prior-year insurance recoveries
related to certain material litigation, partially
offset by lower compensation expense.
Net loss for merger costs related to the Bank One
and the Bank of New York transactions were $130
million, compared with a loss of $189 million in
the prior year. Merger costs were $209 million,
compared with $305 million in the prior year.
Selected metrics
Year ended December 31,
(in millions, except headcount)
2008
2007
2006
Total net revenue
Private equity(a)
$
(963
)
$
3,967
$
1,142
Corporate
1,032
452
(1,128
)
Total net revenue
$
69
$
4,419
$
14
Net
income (loss)
Private equity(a)
$
(690
)
$
2,165
$
627
Corporate(b)(c)
1,458
(150
)
(391
)
Merger-related items(d)
(2,117
)
(130
)
(189
)
Income (loss) from continuing
operations
(1,349
)
1,885
47
Income from discontinued
operations (after-tax)(e)
—
—
795
Income before extraordinary gain
(1,349
)
1,885
842
Extraordinary gain
1,906
—
—
Total net income
$
557
$
1,885
$
842
Headcount
23,376
22,512
23,242
(a)
The Firm adopted SFAS 157 in the first quarter of 2007. See Note 4 on pages
129–143 of this Annual Report for additional information.
(b)
Included a release of credit card litigation reserves in 2008 and insurance
recoveries related to settlement of the Enron and WorldCom class action litigations and
for certain other material legal proceedings of $512 million for full year 2006.
(c)
Includes tax benefits recognized upon resolution of tax audits.
(d)
Includes an accounting conformity loan loss reserve provision related to the
Washington Mutual transaction in 2008. 2008 also reflects items related to the Bear Stearns
merger, which included Bear Stearns’ losses, merger costs, Bear Stearns asset management
liquidation costs and Bear Stearns private client services broker retention expense. Prior
periods represent costs related to the Bank One transaction in 2004 and the Bank of New
York transaction in 2006.
(e)
Included a $622 million gain from the sale of selected corporate trust business in
2006.
2008 compared with 2007
The carrying value of the private equity portfolio
at December 31, 2008, was $6.9 billion, down from
$7.2 billion at December 31, 2007. The portfolio
decrease was primarily driven by unfavorable
valuation adjustments on existing investments,
partially offset by new investments, and the
addition of the Bear Stearns portfolios. The
portfolio represented 5.8% of the Firm’s
stockholders’ equity less goodwill at December 31,2008, down from 9.2% at December 31, 2007.
2007 compared with 2006
The carrying value of the private equity portfolio
at December 31, 2007, was $7.2 billion, up from
$6.1 billion at December 31, 2006. The portfolio
increase was due primarily to favorable valuation
adjustments on nonpublic investments and new
investments, partially offset by sales activity.
The portfolio represented 9.2% of the Firm’s
stockholders’ equity less goodwill at December 31,2007, up from
8.6% at December 31, 2006.
Selected income statement and balance sheet data
Year ended December 31,
(in millions)
2008
2007
2006
Corporate
Securities gains (losses)(a)
$
1,652
$
37
$
(619
)
Investment securities portfolio
(average)(b)
106,801
85,517
63,361
Investment
securities portfolio (ending)(b)
166,662
76,200
82,091
Mortgage loans (average)(c)
7,059
5,639
—
Mortgage loans (ending)(c)
7,292
6,635
—
Private equity
Realized gains
$
1,717
$
2,312
$
1,223
Unrealized gains (losses)(d)(e)
(2,480
)
1,607
(1
)
Total direct investments
(763
)
3,919
1,222
Third-party fund investments
(131
)
165
77
Total private equity gains
(losses)(f)
$
(894
)
$
4,084
$
1,299
Private equity portfolio
information(g)
Direct investments
Publicly held securities
Carrying value
$
483
$
390
$
587
Cost
792
288
451
Quoted public value
543
536
831
Privately held direct securities
Carrying value
5,564
5,914
4,692
Cost
6,296
4,867
5,795
Third-party fund investments(h)
Carrying value
805
849
802
Cost
1,169
1,076
1,080
Total private equity
portfolio – Carrying value
$
6,852
$
7,153
$
6,081
Total private equity portfolio – Cost
$
8,257
$
6,231
$
7,326
(a)
Results for 2008 included a gain on the sale of MasterCard shares. All periods
reflect repositioning of the Corporate investment securities portfolio and exclude
gains/losses on securities used to manage risk associated with MSRs.
(b)
Includes Chief Investment Office investment securities only.
(c)
Held-for-investment prime mortgage loans were transferred from AM to the
Corporate/Private Equity segment for risk management and reporting purposes. The initial
transfer in 2007 had no material impact on the financial results of Corporate/Private
Equity.
(d)
Unrealized gains (losses) contain reversals of unrealized gains and losses that
were recognized in prior periods and have now been realized.
(e)
The Firm adopted SFAS 157 in the first quarter of 2007. For additional
information, see Note 4 on pages 129–143 of this Annual Report.
(f)
Included in principal transactions revenue in the Consolidated Statements of
Income.
(g)
For more information on the Firm’s policies regarding the valuation of the private
equity portfolio, see Note 4 on pages 129–143 of this Annual Report.
(h)
Unfunded commitments to third-party equity funds were $1.4 billion, $881 million
and $589 million at December 31, 2008, 2007 and 2006, respectively.
Federal funds sold and securities purchased
under resale agreements
203,115
170,897
Securities borrowed
124,000
84,184
Trading assets:
Debt and equity instruments
347,357
414,273
Derivative receivables
162,626
77,136
Securities
205,943
85,450
Loans
744,898
519,374
Allowance for loan losses
(23,164
)
(9,234
)
Loans, net of allowance for loan losses
721,734
510,140
Accrued interest and accounts receivable
60,987
24,823
Goodwill
48,027
45,270
Other intangible assets
14,984
14,731
Other assets
121,245
83,633
Total assets
$
2,175,052
$
1,562,147
Liabilities
Deposits
$
1,009,277
$
740,728
Federal funds purchased and securities loaned
or sold under repurchase agreements
192,546
154,398
Commercial paper and other borrowed funds
170,245
78,431
Trading liabilities:
Debt and equity instruments
45,274
89,162
Derivative payables
121,604
68,705
Accounts payable and other liabilities
187,978
94,476
Beneficial interests issued by consolidated VIEs
10,561
14,016
Long-term debt and trust preferred capital
debt securities
270,683
199,010
Total liabilities
2,008,168
1,438,926
Stockholders’ equity
166,884
123,221
Total liabilities and stockholders’
equity
$
2,175,052
$
1,562,147
Consolidated Balance Sheets overview
The following is a discussion of the
significant changes in the Consolidated
Balance Sheets from December 31, 2007.
Deposits with banks; federal funds sold and
securities purchased under resale agreements;
securities borrowed; federal funds purchased and
securities loaned or sold under repurchase
agreements
The Firm utilizes deposits with banks, federal
funds sold and securities purchased under resale
agreements, securities borrowed, and federal funds
purchased and securities loaned or sold under
repurchase agreements as part of its liquidity
management activities to manage the Firm’s cash
positions and risk-based capital requirements and
to support the Firm’s trading and risk management
activities. In particular, the Firm uses
securities purchased under resale agreements and
securities borrowed to provide funding or liquidity
to clients by purchasing and borrowing clients’
securities for the short-term. Federal funds
purchased and securities loaned or sold
under repurchase agreements are used as short-term
funding sources for the Firm and to make securities
available to clients for their short-term purposes.
The increase from December 31, 2007, in deposits
with banks reflected a higher level of interbank
lending; a reclassification of deposits with the
Federal Reserve Bank from cash and due from banks
to deposits with banks reflecting a policy change
of the Federal Reserve Bank to pay interest to
depository institutions on reserve balances, and
assets acquired as a result of the Bear Stearns
merger. The increase in securities borrowed and
securities purchased under resale agreements was
related to assets acquired as a result of the Bear
Stearns merger and growth in demand from clients
for liquidity. The increase in securities sold
under repurchase agreements reflected higher
short-term funding requirements to fulfill clients’
demand for liquidity and finance the Firm’s AFS
securities inventory, and the effect of the
liabilities assumed in connection with the Bear
Stearns merger. For additional information on the
Firm’s Liquidity Risk Management, see pages 76–80
of this Annual Report.
Trading assets and liabilities – debt and equity instruments
The Firm uses debt and equity trading instruments
for both market-making and proprietary risk-taking
activities. These instruments consist predominantly
of fixed income securities, including government
and corporate debt; equity, including convertible
securities; loans, including certain prime mortgage
and other loans warehoused by RFS and IB for sale
or securitization purposes and accounted for at
fair value under SFAS 159; and physical commodities
inventories. The decreases in trading assets and
liabilities – debt and equity instruments from
December 31, 2007, reflected the effect of the
challenging capital markets environment,
particularly for debt securities, partially offset
by positions acquired as a result of the Bear
Stearns merger. For additional information, refer
to Note 4 and Note 6 on pages 129–143 and
146–148, respectively, of this Annual Report.
Trading assets and liabilities – derivative
receivables and payables
Derivative instruments enable end-users to
increase, reduce or alter exposure to credit or
market risks. The value of a derivative is derived
from its reference to an underlying variable or
combination of variables such as interest rate,
credit, foreign exchange, equity or commodity
prices or indices. JPMorgan Chase makes markets in
derivatives for customers, is an end-user of
derivatives for its principal risk-taking
activities, and is also an end-user of derivatives
to hedge or manage risks of market and credit exposures,
modify the interest rate characteristics of related
balance sheet instruments or meet longer-term
investment objectives. The majority of the Firm’s
derivatives are entered into for market-making
purposes. The increase in derivative receivables
and payables from December 31, 2007, was primarily
related to the decline in interest rates, widening
credit spreads and volatile foreign exchange rates
reflected in interest rate, credit and foreign
exchange derivatives, respectively. The increase
also included positions acquired in the Bear
Stearns merger. For additional information, refer
to derivative contracts, Note 4, Note 6 and Note 32
on pages 129–143, 146–148, and 202–205,
respectively, of this Annual Report.
Securities
Almost all of the Firm’s securities portfolio is
classified as AFS and is used predominantly to
manage the Firm’s exposure to interest rate
movements, as well as to make strategic longer-term
investments. The AFS portfolio increased from
December 31, 2007, predominantly as a result of
purchases, partially offset by sales and
maturities. For additional information related to
securities, refer to the Corporate/Private Equity
segment discussion, Note 4 and Note 12 on pages
61–63, 129–143 and 158–162, respectively, of
this Annual Report.
Loans and allowance for loan losses
The Firm provides loans to a variety of customers,
from large corporate and institutional clients to
individual consumers. Loans increased from December31, 2007, largely due to loans acquired in the
Washington Mutual transaction, organic growth in
lending in the wholesale businesses, particularly
CB, and growth in the consumer prime mortgage
portfolio driven by the decision to retain, rather
than sell, new originations of nonconforming
mortgage loans.
Both the consumer and wholesale components of the
allowance for loan losses increased from the prior
year reflecting the addition of noncredit-impaired
loans acquired in the Washington Mutual
transaction, including an increase to conform the allowance applicable to assets acquired from Washington Mutual to the
Firm’s loan loss methodologies. Excluding the
Washington Mutual transaction the consumer
allowance rose due to an increase in estimated
losses for home equity, subprime mortgage, prime
mortgage and credit card loans due to the effects
of continued housing price declines, rising
unemployment and a weakening economic environment.
Excluding the Washington Mutual transaction, the
increase in the wholesale allowance was due to the
impact of the transfer of $4.9 billion of funded
and unfunded leveraged lending loans in IB to the
retained loan portfolio from the held-for-sale loan
portfolio, the effect of a weakening credit environment and loan growth. For a more detailed
discussion of the loan portfolio and the allowance
for loan losses, refer to Credit Risk Management on
pages 80–99, and Notes 4, 5, 14 and 15 on pages
129–143, 144–146, 163–166 and 166–168,
respectively, of this Annual Report.
Accrued interest and accounts receivable; accounts
payable and other liabilities
The Firm’s accrued interest and accounts receivable
consist of accrued interest receivable from
interest-earning assets; receivables from customers
(primarily from activities related to IB’s Prime
Services business);
receivables from brokers, dealers and clearing
organizations; and receivables from failed
securities sales. The Firm’s accounts payable and
other liabilities consist of accounts payable to
customers (primarily from activities related to
IB’s Prime Services business), payables to brokers,
dealers and clearing organizations; payables from
failed securities purchases; accrued expense,
including for interest-bearing liabilities; and all
other liabilities, including obligations to return
securities received as collateral. The increase in
accrued interest and accounts receivable from
December 31, 2007, was due largely to the Bear
Stearns merger, reflecting higher customer
receivables in IB’s Prime Services business and the
Washington Mutual transaction. The increase in
accounts payable and other liabilities
was predominantly due to the Bear Stearns merger,
reflecting higher customer payables (primarily
related to IB’s Prime Services business), as well
as higher obligations to return securities received
as collateral. For additional information, see Note
22 on page 190 of this Annual Report.
Goodwill
Goodwill arises from business combinations and
represents the excess of the cost of an acquired
entity over the net fair value amounts assigned to
assets acquired and liabilities assumed. The
increase in goodwill was due predominantly to the
dissolution of Chase Paymentech Solutions joint
venture, the merger with Bear Stearns, the purchase
of an additional equity interest in Highbridge and
tax-related purchase accounting adjustments
associated with the Bank One merger, which
increased goodwill attributed to IB. These
items were offset partially by a decrease in
goodwill attributed to TSS predominantly resulting
from the sale of a previously consolidated
subsidiary. For additional information, see Note 18
on pages 186–189 of this Annual Report.
Other intangible assets
The Firm’s other intangible assets consist of MSRs,
purchased credit card relationships, other credit
card-related intangibles, core deposit intangibles,
and other intangibles. MSRs increased due to the
Washington Mutual transaction and the Bear Stearns
merger; sales in RFS of originated loans; and
purchases of MSRs. These increases in MSRs were
partially offset by markdowns of the fair value of
the MSR asset due to changes to inputs and
assumptions in the MSR valuation model, including
updates to prepayment assumptions to reflect
current expectations, and to servicing portfolio
run-offs. The decrease in other intangible assets
reflects amortization expense associated with
credit card-related and core deposit intangibles,
partially offset by increases due to the
dissolution of the Chase Paymentech Solutions joint
venture, the purchase of an additional equity
interest in Highbridge, and the acquisition of an
institutional global custody portfolio. For
additional information on MSRs and other intangible
assets, see Note 18 on pages 186–189 of this
Annual Report.
Other assets
The Firm’s other assets consist of private equity
and
other investments, collateral received, corporate
and bank-owned life insurance policies, premises
and equipment, assets acquired in loan satisfaction
(including real estate owned), and all other
assets. The increase in other assets from December31, 2007, was due to the Bear Stearns merger, which
partly resulted in a higher volume of collateral
received from customers, the Washington Mutual
transaction, and the purchase of asset-backed
commercial paper from money market mutual funds in
connection with the Federal Reserve’s Asset-Backed
Commercial Paper Money Market Mutual Fund Liquidity
Facility (“AML Facility”), which was established by
the Federal Reserve on September 19, 2008, as a
temporary lending facility to provide liquidity to
eligible MMMFs. For additional information
regarding the AML Facility, see Executive Overview
and Note 22 on pages 29–32 and 190 respectively,
of this Annual Report.
Deposits
The Firm’s deposits represent a liability to
customers, both retail and wholesale, related to
non-brokerage funds held on their behalf. Deposits
are generally classified by location (U.S. and
non-U.S.), whether they are interest or
noninterest-bearing, and by type (i.e., demand,
money market deposit, savings, time or negotiable
order of withdrawal accounts). Deposits help
provide a stable and consistent source of funding
for the Firm. Deposits were at a higher level
compared with the level at December 31, 2007,
predominantly from the deposits assumed in the
Washington Mutual transaction, net increases in
wholesale interest- and noninterest-bearing
deposits in TSS, AM and CB. The increase in TSS was
driven by both new and existing clients, and due to
the deposit inflows related to the heightened
volatility and credit concerns affecting the
markets. For more information on deposits, refer to
the TSS and RFS segment discussions on pages 56–57
and 45–50, respectively, and the Liquidity Risk
Management discussion on pages 76–80 of this
Annual Report. For more information on wholesale
liability balances, including deposits, refer to
the CB and TSS segment discussions on pages 54–55
and 56–57 of this Annual Report.
Commercial paper and other borrowed funds
The Firm utilizes commercial paper and other
borrowed funds as part of its liquidity management
activities to meet short-term funding needs, and in
connection with a TSS liquidity management product
whereby excess client funds, are transferred into
commercial paper overnight sweep accounts. The
increase in other borrowed funds was predominantly
due to advances from Federal Home Loan Banks of
$70.2 billion (net of maturities of $10.4 billion)
that were assumed as part of the Washington Mutual
transaction and nonrecourse advances from the
Federal Reserve Bank of Boston (“FRBB”) to fund
purchases of asset-backed commercial paper from money market mutual
funds, and other borrowings from the Federal
Reserve under the Term Auction Facility program.
For additional information on the Firm’s Liquidity
Risk Management and other borrowed funds, see pages
76–80 and Note 21 on page 190 of this Annual
Report.
Long-term debt and trust preferred capital debt securities
The Firm utilizes long-term debt and trust
preferred capital debt securities to provide
cost-effective and diversified sources of funds and
as critical components of the Firm’s liquidity and
capital management. Long-term debt and trust
preferred capital debt securities increased from
December 31, 2007, predominantly due to debt
assumed in both the Bear Stearns merger and the
Washington Mutual transaction, and debt issuances
of $20.8 billion, which are guaranteed by the FDIC
under its Temporary Liquidity Guarantee Program
(the “TLG Program”). These increases were partially
offset by net maturities and redemptions, including
IB structured notes, the issuances of which are
generally client-driven. For additional information
on the Firm’s long-term debt activities, see the
Liquidity Risk Management discussion on pages
76–80 and Note 23 on pages 191–192 of this Annual
Report.
Stockholders’ equity
The increase in total stockholders’ equity from
December 31, 2007, was predominantly due to the
issuance of preferred and common equity securities
during 2008. In the fourth quarter of 2008,
JPMorgan Chase participated in the Capital Purchase
Program and issued preferred stock and a warrant to
purchase common stock to the U.S. Treasury,
resulting in a $25.0 billion increase to
stockholders’ equity. Additional preferred stock
issuances and a common stock issuance during 2008
increased equity by $19.3 billion. Equity from
issuances of stock awards under the Firm’s employee
stock-based compensation plans, the Bear Stearns
merger, and net income for 2008 was more than
offset by the declaration of cash dividends and net
losses recorded within accumulated other
comprehensive income related to AFS securities and
defined benefit pension and OPEB plans. For a
further discussion, see the Capital Management
section that follows, and Note 24 and Note 27 on
pages 193–194 and 196–197, respectively, of this
Annual Report.
OFF-BALANCE SHEET ARRANGEMENTS AND CONTRACTUAL CASH OBLIGATIONS
JPMorgan Chase is involved with several types
of off-balance sheet arrangements, including
special purpose entities (“SPEs”) and
lending-related financial instruments (e.g.,
commitments and guarantees).
Special-purpose entities
The basic SPE structure involves a company
selling assets to the SPE. The SPE funds the
purchase of those assets by issuing securities to
investors in the form of commercial paper,
short-term asset-backed notes, medium-term notes
and other forms of interest. SPEs are generally
structured to insulate investors from claims on the
SPE’s assets by creditors of other entities,
including the creditors of the seller of the
assets.
SPEs are an important part of the financial
markets, providing market liquidity by facilitating
investors’ access to specific portfolios of assets
and risks. These arrangements are integral to the
markets for mortgage-backed securities, commercial
paper and other asset-backed securities.
JPMorgan Chase uses SPEs as a source of liquidity
for itself and its clients by securitizing
financial assets, and by creating investment
products for clients. The Firm is involved with
SPEs through multi-seller conduits and investor
intermediation activities, and as a result of its
loan securitizations, through qualifying special
purpose entities (“QSPEs”). This discussion focuses
mostly on multi-seller conduits and investor
intermediation. For a detailed discussion of all
SPEs with which the Firm is involved, and the
related accounting, see Note 1, Note 16 and Note 17
on pages 122–123, 168–176 and 177–186,
respectively of this Annual Report.
The Firm holds capital, as deemed appropriate,
against all SPE-related transactions and related
exposures, such as derivative transactions and
lending-related commitments and guarantees.
The Firm has no commitments to issue its own stock
to support any SPE transaction, and its policies
require that transactions with SPEs be conducted
at arm’s length and reflect market pricing.
Consistent with this policy, no JPMorgan Chase
employee is permitted to invest in SPEs with which
the Firm is involved where such investment would
violate the Firm’s Code of Conduct. These rules
prohibit employees from self-dealing and acting on
behalf of the Firm in transactions with which they
or their family have any significant financial
interest.
Implications of a credit rating
downgrade to
JPMorgan Chase Bank,
N.A.
For certain liquidity commitments to SPEs, the Firm
could be required to provide funding if the
short-term credit rating of JPMorgan Chase Bank,
N.A., was downgraded below specific levels,
primarily “P-1”,
“A-1” and “F1” for Moody’s, Standard & Poor’s and
Fitch,
respectively. The amount of these liquidity
commitments was $61.0 billion and $94.0 billion at
December 31, 2008 and 2007, respectively.
Alternatively, if JPMorgan Chase Bank, N.A., were
downgraded, the Firm could be replaced by another
liquidity provider in lieu of providing funding
under the liquidity commitment, or in certain
circumstances,
the Firm could facilitate the sale or
refinancing of the assets in the SPE in order to
provide liquidity. These commitments are included
in other unfunded commitments to extend credit and
asset purchase agreements, as shown in the
Off-balance sheet lending-related financial
instruments and guarantees table on page 69 of this
Annual Report.
As noted above, the Firm is involved with three
types of SPEs. A summary of each type of SPE
follows.
Multi-seller conduits
The Firm helps customers meet their financing needs
by providing access to the commercial paper markets
through variable interest entities (“VIEs”) known
as multi-seller conduits. Multi-seller conduit
entities are separate bankruptcy-remote entities
that purchase interests in, and make loans secured
by, pools of receivables and other financial assets
pursuant to agreements with customers of the Firm.
The conduits fund their purchases and loans through
the issuance of highly rated commercial paper to
third-party investors. The primary source of
repayment of the commercial paper is the cash flow
from the pools of assets. JPMorgan Chase receives
fees related to the structuring of multi-seller
conduit transactions and receives compensation from
the multi-seller conduits for its role as
administrative agent, liquidity provider, and
provider of program-wide credit enhancement.
Investor intermediation
As a financial intermediary, the Firm creates
certain types of VIEs and also structures
transactions, typically derivative structures, with
these VIEs to meet investor needs. The Firm may
also provide liquidity and other support. The risks
inherent in derivative instruments or liquidity
commitments are managed similarly to other credit,
market and liquidity risks to which the Firm is
exposed. The principal types of VIEs the Firm uses
in these structuring activities are municipal bond
vehicles, credit-linked note vehicles and
collateralized debt obligation vehicles.
Loan securitizations
JPMorgan Chase securitizes and sells a variety of
loans, including residential mortgages, credit
cards, automobile, student, and commercial loans
(primarily related to real estate). JPMorgan
Chase-sponsored securitizations utilize SPEs as
part of the securitization process. These SPEs are
structured to meet the definition of a QSPE (as
discussed in Note 1 on page 122 of this Annual
Report); accordingly, the assets and liabilities of
securitization-related QSPEs are not reflected on
the Firm’s Consolidated Balance Sheets (except for
retained interests, as described below). The
primary purpose of these vehicles is to meet
investor needs and generate liquidity for the Firm
through the
sale of loans to the QSPEs. These QSPEs are
financed through the issuance of fixed or
floating-rate asset-backed securities that are sold
to third-party investors or held by the Firm.
Consolidation and consolidation sensitivity analysis on capital
For more information regarding these programs and
the Firm’s other SPEs, as well as the Firm’s
consolidation analysis for these programs, see Note
16 and Note 17 on pages 168–176 and 177–186,
respectively, of this Annual Report.
Special-purpose entities revenue
The following table summarizes certain revenue
information related to consolidated and
nonconsolidated VIEs and QSPEs with which the Firm
has significant involvement. The revenue reported
in the table below primarily represents contractual
servicing and credit fee income (i.e., for income
from acting as administrator, structurer, liquidity
provider). It does not include mark-to-market gains
and losses from changes in the fair value of
trading positions (such as derivative transactions)
entered into with VIEs. Those gains and losses are
recorded in principal transactions revenue.
Revenue from VIEs and QSPEs
Year ended December 31,
(in millions)
2008
2007
2006
VIEs:(a)
Multi-seller conduits
$
314
$
187
(b)
$
160
Investor intermediation
18
33
49
Total VIEs
332
220
209
QSPEs(c)
1,746
1,420
1,131
Total
$
2,078
$
1,640
$
1,340
(a)
Includes revenue associated with consolidated VIEs and significant nonconsolidated
VIEs.
(b)
Excludes the markdown on subprime CDO assets that was recorded in principal
transactions revenue in 2007.
(c)
Excludes servicing revenue from loans sold to and securitized
by third parties. Prior period amounts have been revised to conform to the current period presentation.
American Securitization Forum subprime
adjustable rate mortgage loans modifications
In December 2007, the American Securitization Forum
(“ASF”) issued the “Streamlined Foreclosure and
Loss Avoidance Framework for Securitized Subprime
Adjustable Rate Mortgage Loans” (“the Framework”).
The Framework provides guidance for servicers to
streamline evaluation procedures of borrowers with
certain subprime adjustable rate mortgage (“ARM”)
loans to more efficiently provide modification of
such loans with terms that are more appropriate for
the individual needs of such borrowers. The
Framework applies to all first-lien subprime ARM
loans that have a fixed rate of interest for an
initial period of 36 months or less; are included
in
securitized pools; were originated between January1, 2005, and July 31, 2007; and have an initial
interest rate reset date between January 1, 2008,
and July 31, 2010. The Framework categorizes the
population of ASF Framework Loans into three
segments. Segment 1 includes loans where the
borrower is current and likely to be able to
refinance into any available mortgage product.
Segment 2 includes loans where the borrower is
current, unlikely to be able to refinance into any
readily available mortgage industry product and
meets certain defined criteria. Segment 3 includes
loans where the borrower is not current, as
defined, and does not meet the criteria for
Segments 1 or 2.
JPMorgan Chase adopted the Framework during the
first quarter of 2008. For those AFS Framework
Loans serviced by the Firm and owned by
Firm-sponsored QSPEs, the Firm modified principal
amounts of $1.7 billion of Segment 2 subprime
mortgages during the year ended December 31, 2008.
The following table presents selected information
relating to the principal amount of Segment 3
loans for the year ended December 31, 2008, including those that
have been modified, subjected to other loss mitigation activities or
have been prepaid by the borrower.
Year ended December 31, (in millions)
2008
Loan modifications
$
2,384
Other loss mitigation activities
865
Prepayments
219
For additional discussion of the Framework,
see Note 16 on page 176 of this Annual Report.
Off-balance sheet lending-related financial
instruments and guarantees
JPMorgan Chase utilizes lending-related
financial instruments (e.g., commitments and
guarantees) to meet the financing needs of its
customers. The contractual amount of these
financial instruments represents the maximum
possible credit risk should the counterparty draw
upon the commitment or the Firm be required to
fulfill its obligation under the guarantee, and
the counterparty subsequently fail to perform
according to the terms of the contract. These
commitments and guarantees historically expire
without being drawn and even higher proportions
expire without a default. As a result, the total
contractual amount of these instruments is not, in
the Firm’s view, representative of its actual
future credit exposure or funding requirements.
Further, certain commitments, primarily related to
consumer financings, are cancelable, upon notice,
at the option of the Firm. For further discussion
of lending-related commitments and guarantees and
the Firm’s accounting for them, see
lending-related commitments in Credit Risk
Management on page 90 and Note 33 on pages
206–210 of this Annual Report.
Contractual cash obligations
In the normal course of business, the Firm
enters into various contractual obligations that
may require future cash payments. Commitments for
future cash expenditures primarily include
contracts to purchase
future services and capital expenditures related to
real estate–related obligations and equipment.
The accompanying table summarizes, by remaining
maturity, JPMorgan Chase’s off-balance sheet
lending-related financial instruments and
significant contractual cash obligations at
December 31, 2008. Contractual purchases and
capital expenditures in the table below reflect
the minimum contractual obligation under legally
enforceable contracts with terms that are both
fixed and determinable. Excluded from the
following table are a number of obligations to be
settled in cash, primarily in under one year.
These obligations are reflected on the Firm’s
Consolidated Balance Sheets and include federal
funds purchased and securities loaned or sold
under repurchase agreements; commercial paper;
other borrowed funds; purchases of debt and equity
instruments; derivative payables; and certain
purchases of instruments that resulted in
settlement failures. Also excluded are contingent
payments associated with certain acquisitions that
could not be estimated. For discussion regarding
long-term debt and trust preferred capital debt
securities, see Note 23 on pages 191–192 of this
Annual Report. For discussion regarding operating
leases, see Note 31 on page 201 of this Annual
Report.
Other unfunded commitments to extend
credit(b)(c)(d)(e)
93,307
69,479
53,567
9,510
225,863
250,954
Asset purchase agreements(f)
16,467
25,574
9,983
1,705
53,729
90,105
Standby letters of credit and guarantees(c)(g)(h)
25,998
35,288
30,650
3,416
95,352
100,222
Other letters of credit(c)
3,889
718
240
80
4,927
5,371
Total wholesale
139,661
131,059
94,440
14,711
379,871
446,652
Total lending-related
$
782,639
$
135,157
$
104,356
$
99,226
$
1,121,378
$
1,262,588
Other guarantees
Securities lending guarantees(i)
$
169,281
$
—
$
—
$
—
$
169,281
$
385,758
Residual value guarantees
—
670
—
—
670
NA
Derivatives qualifying as guarantees(j)
9,537
28,970
15,452
29,876
83,835
85,262
Contractual cash obligations
By remaining maturity at December 31,
(in millions)
Time deposits
$
278,520
$
11,414
$
8,139
$
1,028
$
299,101
$
249,877
Advances
from the Federal Home Loan Banks
47,406
21,089
738
954
70,187
450
Long-term debt
36,026
78,199
51,275
86,594
252,094
183,862
Trust preferred capital debt securities
—
—
—
18,589
18,589
15,148
FIN 46R long-term beneficial interests(k)
67
199
1,289
3,450
5,005
7,209
Operating leases(l)
1,676
3,215
2,843
9,134
16,868
10,908
Contractual purchases and capital expenditures
1,356
878
219
234
2,687
2,434
Obligations under affinity and co-brand programs
1,174
2,086
1,999
2,879
8,138
5,477
Other liabilities(m)
666
809
865
2,665
5,005
5,656
Total
$
366,891
$
117,889
$
67,367
$
125,527
$
677,674
$
481,021
(a)
Includes credit card and home equity lending-related commitments of $623.7 billion
and $95.7 billion, respectively, at December 31, 2008; and $714.8 billion and $74.2
billion, respectively, at December 31, 2007. These amounts for credit card and home equity
lending-related commitments represent the total available credit for these products. The
Firm has not experienced, and does not anticipate, that all available lines of credit for
these products will be utilized at the same time. The Firm can reduce or cancel these
lines of credit by providing the borrower prior notice or, in some cases, without notice
as permitted by law.
(b)
Includes unused advised lines of credit totaling $36.3 billion and $38.4 billion
at December 31, 2008 and 2007, respectively, which are not legally binding. In regulatory
filings with the Federal Reserve, unused advised lines are not reportable. See the
Glossary of terms, on page 218 of this Annual Report, for the Firm’s definition of advised
lines of credit.
(c)
Represents contractual amount net of risk participations totaling $28.3 billion at
both December 31, 2008 and 2007.
(d)
Excludes unfunded commitments to third-party private equity funds of $1.4 billion
and $881 million at December 31, 2008 and 2007, respectively. Also excluded unfunded
commitments for other equity investments of $1.0 billion and $903 million at December 31,2008 and 2007, respectively.
(e)
Includes commitments to investment and noninvestment grade counterparties in
connection with leveraged acquisitions of $3.6 billion and $8.2 billion at December 31,2008 and 2007, respectively.
(f)
Largely represents asset purchase agreements to the Firm’s administered
multi-seller, asset-backed commercial paper conduits. The maturity is based upon the
weighted-average life of the underlying assets in the SPE, which are based upon the
remainder of each conduit transaction’s committed liquidity plus either the expected
weighted average life of the assets should the committed liquidity expire without renewal,
or the expected time to sell the underlying assets in the securitization market. It also
includes $96 million and $1.1 billion of asset purchase agreements to other third-party
entities at December 31, 2008 and 2007, respectively.
(g)
JPMorgan Chase held collateral relating to $31.0 billion and $31.5 billion of
these arrangements at December 31, 2008 and 2007, respectively. Prior periods have been
revised to conform to the current presentation.
(h)
Includes unissued standby letters of credit commitments of $39.5 billion and $50.7
billion at December 31, 2008 and 2007, respectively.
(i)
Collateral held by the Firm in support of securities lending indemnification
agreements was $170.1 billion and $390.5 billion at December 31, 2008 and 2007,
respectively. Securities lending collateral comprises primarily cash, securities issued by
governments that are members of the Organisation for Economic Co-operation and Development
and U.S. government agencies.
(j)
Represents notional amounts of derivatives qualifying as guarantees. For further
discussion of guarantees, see Note 33 on pages 206–210 of this Annual Report.
(k)
Included on the Consolidated Balance Sheets in beneficial interests issued by
consolidated variable interest entities.
(l)
Includes noncancelable operating leases for premises and equipment used primarily
for banking purposes and for energy-related tolling service agreements. Excludes the
benefit of noncancelable sublease rentals of $2.3 billion and $1.3 billion at December 31,2008 and 2007, respectively.
(m)
Includes deferred annuity contracts. Excludes the $1.3 billion discretionary
contribution to the Firm’s U.S. defined benefit pension plan that was made on January 15,2009 (for further discussion, see Note 9 on pages 149–155), and contributions to the U.S.
and non-U.S. other postretirement benefits plans, if any, as these contributions are not
reasonably estimable at this time. Also excluded are unrecognized tax benefits of $5.9
billion and $4.8 billion at December 31, 2008 and 2007, respectively, as the timing and
amount of future cash payments are not determinable at this time.
The Firm’s capital management framework is
intended to ensure that there is capital sufficient
to support the underlying risks of the Firm’s
business activities and to maintain
“well-capitalized” status under regulatory
requirements. In addition, the Firm holds capital
above these requirements in amounts deemed
appropriate to achieve the Firm’s regulatory and
debt rating objectives. The process of assigning
equity to the lines of business is integrated into
the Firm’s capital framework and is overseen by the
ALCO.
Line of business equity
The Firm’s framework for allocating capital is
based upon the following objectives:
•
integrate firmwide capital management activities with capital management activities
within each of the lines of business
•
measure performance consistently across all lines of business
•
provide comparability with peer firms for each of the lines of business
Equity for a line of business represents the amount
the Firm believes the business would require if it
were operating independently, incorporating
sufficient capital to address economic risk
measures, regulatory capital requirements and
capital levels for similarly rated peers. Capital
is also allocated to each line of business for,
among other things, goodwill and other intangibles
associated with acquisitions effected by the line
of business. Return on common equity is measured
and internal targets for expected returns are
established as a key measure of a business
segment’s performance.
Relative to 2007, line of business equity increased
during 2008, reflecting growth across the
businesses. In addition, at the end of the third
quarter of 2008, equity was increased for each line
of business in anticipation of the future
implementation of the new Basel II capital rules.
For further details on these rules, see Basel II on
page 72 of this Annual Report. Finally, during
2008, capital allocated to RFS, CS, and CB was
increased as a result of the Washington Mutual
transaction; capital allocated to AM was increased
due to the Bear Stearns merger and the purchase of
the additional equity interest in Highbridge; and
capital allocated to IB was increased due to the
Bear Stearns merger.
In accordance with SFAS 142, the lines of
business perform the required goodwill impairment
testing. For a further discussion of goodwill and
impairment testing, see Critical Accounting
Estimates Used by the Firm and Note 18 on pages
107–111 and 186–189, respectively, of this
Annual Report.
Line of business equity
December 31, (in billions)
2008
2007
Investment Bank
$
33.0
$
21.0
Retail Financial Services
25.0
16.0
Card Services
15.0
14.1
Commercial Banking
8.0
6.7
Treasury & Securities Services
4.5
3.0
Asset Management
7.0
4.0
Corporate/Private Equity
42.4
58.4
Total common stockholders’ equity
$
134.9
$
123.2
Line of business equity
Yearly Average
(in billions)
2008
2007
Investment Bank
$
26.1
$
21.0
Retail Financial Services
19.0
16.0
Card Services
14.3
14.1
Commercial Banking
7.3
6.5
Treasury & Securities Services
3.8
3.0
Asset Management
5.6
3.9
Corporate/Private Equity(a)
53.0
54.2
Total common stockholders’ equity
$
129.1
$
118.7
(a)
2008 and 2007 include $41.9 billion and $41.7 billion, respectively, of equity to
off-set goodwill, and $11.1 billion and $12.5 billion, respectively, of equity, primarily
related to Treasury, Private Equity and the Corporate pension plan.
Economic risk capital
JPMorgan Chase assesses its capital adequacy
relative to the risks underlying the Firm’s
business activities, utilizing internal
risk-assessment methodologies. The Firm assigns
economic capital primarily based upon four risk
factors: credit risk, market risk, operational risk
and private equity risk. In 2008, the growth in
economic risk capital was driven by higher credit
risk capital, which was increased primarily due to
a combination of higher derivative exposure, a
weakening credit environment, and asset growth
related to the Bear Stearns and Washington Mutual
transactions.
Economic risk capital
Yearly Average
(in billions)
2008
2007
Credit risk
$
37.8
$
30.0
Market risk
10.5
9.5
Operational risk
6.3
5.6
Private equity risk
5.3
3.7
Economic risk capital
59.9
48.8
Goodwill
46.1
45.2
Other(a)
23.1
24.7
Total common stockholders’ equity
$
129.1
$
118.7
(a)
Reflects additional capital required, in the Firm’s view, to meet its regulatory
and debt rating objectives.
Credit risk capital
Credit risk capital is estimated separately for the
wholesale businesses (IB, CB, TSS and AM) and
consumer businesses (RFS and CS).
Credit risk capital for the overall wholesale
credit portfolio is defined in terms of unexpected
credit losses, both from defaults and declines in
the portfolio value due to credit deterioration,
measured over a one-year period at a confidence
level consistent with an “AA” credit rating
standard. Unexpected losses are losses in excess of
those for which provisions for credit losses are
maintained. The capital methodology is based upon
several principal drivers of credit risk: exposure
at default (or loan-equivalent amount), default
likelihood, credit spreads, loss severity and
portfolio correlation.
Credit risk capital for the consumer portfolio is
based upon product and other relevant risk
segmentation. Actual segment level default and
severity experience are used to estimate unexpected
losses for a one-year horizon at a confidence level
consistent with an “AA” credit rating standard.
Statistical results for certain segments or
portfolios are adjusted to ensure that capital is
consistent with external benchmarks, such as
subordination levels on market transactions or
capital held at representative monoline
competitors, where appropriate.
Market risk capital
The Firm calculates market risk capital guided by
the principle that capital should reflect the risk
of loss in the value of portfolios and financial
instruments caused by adverse movements in market
variables, such as interest and foreign exchange
rates, credit spreads, securities prices and
commodities prices. Daily Value-at-Risk (“VaR”),
biweekly stress-test results and other factors are
used to determine appropriate capital levels. The
Firm allocates market risk capital to each business
segment according to a formula that weights that
segment’s VaR and stress-test exposures. See Market
Risk Management on pages 99–104 of this Annual
Report for more information about these market risk
measures.
Operational risk capital
Capital is allocated to the lines of business for
operational risk using a risk-based capital
allocation methodology which estimates operational
risk on a bottom-up basis. The operational risk
capital model is based upon actual losses and
potential scenario-based stress losses, with
adjustments to the capital calculation to reflect
changes in the quality of the control environment
or the use of risk-transfer products. The Firm
believes its model is consistent with the new Basel
II Framework.
Private equity risk capital
Capital is allocated to privately and publicly held
securities, third-party fund investments and
commitments in the private equity portfolio to
cover the potential loss associated with a decline
in equity markets and related asset devaluations.
In addition to negative market fluctuations,
potential losses in private equity investment
portfolios can be magnified by liquidity risk. The
capital allocation for the private equity portfolio
is based upon measurement of the loss experience
suffered by the Firm and other market participants
over a prolonged period of adverse equity market
conditions.
Regulatory capital
The Board of Governors of the Federal Reserve
System (the “Federal Reserve”) establishes capital
requirements, including well-capitalized standards
for the consolidated financial holding company. The
Office of the Comptroller of the Currency (“OCC”)
establishes similar capital requirements and
standards for the Firm’s national banks, including
JPMorgan Chase Bank, N.A., and Chase Bank USA, N.A.
The Federal Reserve granted the Firm, for a period
of 18
months following the Bear Stearns merger, relief up
to a certain specified amount and subject to certain
conditions from the Federal Reserve’s risk-based
capital and leverage requirements with respect to
Bear Stearns’ risk-weighted assets and other
exposures acquired. The amount of such relief is
subject to reduction by one-sixth each quarter
subsequent to the merger and expires on October 1,2009. The OCC granted JPMorgan Chase Bank, N.A.
similar relief from its risk-based capital and
leverage requirements.
JPMorgan Chase maintained a well-capitalized
position, based upon Tier 1 and Total capital
ratios at December 31, 2008 and 2007, as indicated
in the tables below. For more information, see
Note 30 on pages 200–201 of this Annual Report.
Risk-based capital components and assets
December 31, (in millions)
2008
2007
Total Tier 1
capital(a)
$
136,104
$
88,746
Total Tier 2 capital
48,616
43,496
Total capital
$
184,720
$
132,242
Risk-weighted assets
$
1,244,659
$
1,051,879
Total adjusted average assets
1,966,895
1,473,541
(a)
The FASB has been deliberating certain amendments to both
SFAS 140 and FIN 46R that may impact the accounting for
transactions that involve QSPEs and VIEs. Based on the provisions of
the current proposal and the Firm's interpretation of the proposal,
the Firm estimates that the impact of consolidation could be up to
$70 billion of credit card receivables, $40 billion of
assets related to Firm-sponsored multi-seller conduits, and
$50 billion of other loans (including residential mortgages);
the decrease in the Tier 1 capital ratio could be approximately
80 basis points. The ultimate impact could differ significantly
due to the FASB's continuing deliberations on the final requirements
of the rule and market conditions.
Tier 1 capital was $136.1 billion at December31, 2008, compared with $88.7 billion at December31, 2007, an increase of $47.4 billion.
Additional information regarding the Firm’s
capital ratios and the federal regulatory capital
standards to which it is subject, and the capital
ratios for the Firm’s significant banking
subsidiaries at December 31, 2008 and 2007, are
presented in Note 30 on pages 200–201 of this
Annual Report.
Capital Purchase Program
Pursuant to the Capital Purchase Program, on
October 28, 2008, the Firm issued to the U.S.
Treasury, for total proceeds of $25.0 billion,
(i)
2.5 million shares of Series K Preferred Stock, and
(ii) a Warrant to purchase up to 88,401,697 shares
of the Firm’s common stock, at an exercise price of
$42.42 per share, subject to certain antidilution
and other adjustments. The Series K Preferred Stock
qualifies as Tier 1 capital.
The Series K Preferred Stock bears cumulative
dividends at a rate of 5% per year for the first
five years and 9% per year thereafter. The Series K Preferred
Stock ranks equally with the Firm’s existing 6.15%
Cumulative Preferred Stock, Series E;
5.72% Cumulative Preferred Stock, Series F;
5.49% Cumulative Preferred Stock, Series G;
Fixed-to-Floating Rate Noncumulative Perpetual
Preferred Stock, Series I; and 8.63%
Noncumulative Perpetual Preferred Stock, Series
J, in terms of dividend payments and upon
liquidation of the Firm.
Any accrued and unpaid dividends on the Series K
Preferred Stock must be fully paid before dividends
may be declared or paid on stock ranking junior or
equally with the Series K Preferred Stock. Pursuant to the Capital Purchase Program, until October 28, 2011, the U.S. Treasury’s consent
is required for any increase in dividends on the Firm’s common
stock from the amount of the last quarterly stock dividend declared
by the Firm prior to October 14, 2008, unless the Series K
Preferred Stock is redeemed in whole before then, or the U.S.
Treasury has transferred all of the Series K Preferred Stock it
owns to third parties.
The Firm may not repurchase or redeem any common
stock or other equity securities of the Firm, or
any trust preferred securities issued by the Firm
or any of its affiliates, without the prior
consent of the U.S. Treasury (other than (i)
repurchases of the Series K Preferred Stock and
(ii) repurchases of junior preferred shares or
common stock in connection with any employee
benefit plan in the ordinary course of business
consistent with past practice).
Basel II
The minimum risk-based capital requirements adopted
by the U.S. federal banking agencies follow the
Capital Accord of the Basel Committee on Banking
Supervision. In 2004, the Basel Committee published
a revision to the Accord (“Basel II”). The goal of
the new Basel II Framework is to provide more
risk-sensitive regulatory capital calculations and
promote enhanced risk management practices among
large, internationally active banking
organizations. U.S. banking regulators published a
final Basel II rule in December 2007, which will
require JPMorgan Chase to implement Basel II at the
holding company level, as well as at certain of its
key U.S. bank subsidiaries.
Prior to full implementation of the new Basel II
Framework, JPMorgan Chase will be required to
complete a qualification period of four consecutive
quarters during which it will need to demonstrate
that it meets the requirements of the new rule to
the satisfaction of its primary U.S. banking
regulators. The U.S. implementation timetable
consists of the qualification period, starting any
time between April 1, 2008, and April 1, 2010,
followed by a minimum transition period of three
years. During the transition period, Basel II
risk-based capital requirements cannot fall below
certain floors based on current (“Basel l”)
regulations. JPMorgan Chase expects to be in
compliance with all relevant Basel II rules within
the established timelines. In addition, the Firm
has adopted, and will continue to adopt, based upon
various established timelines, Basel II in certain
non-U.S. jurisdictions, as required.
Broker-dealer regulatory capital
JPMorgan Chase’s principal U.S. broker-dealer
subsidiaries are J.P. Morgan Securities Inc.
(“JPMorgan Securities”) and J.P. Morgan Clearing
Corp. (formerly known as Bear Stearns Securities
Corp.). JPMorgan Securities and J.P. Morgan
Clearing Corp. are each subject to Rule 15c3-1
under the Securities Exchange Act of 1934 (“Net
Capital Rule”). JPMorgan Securities and J.P. Morgan
Clearing Corp. are also registered as futures
commission merchants and subject to Rule 1.17
under the Commodity Futures Trading Commission
(“CFTC”).
JPMorgan
Securities and J.P. Morgan Clearing Corp. have elected to compute
their minimum net capital requirements in accordance with
the “Alternative Net Capital Requirement” of the Net
Capital Rule. At December 31, 2008, JPMorgan
Securities’ net capital, as defined by the Net
Capital Rule, of $7.2 billion exceeded the minimum
requirement by $6.6 billion. In addition to its net
capital requirements, JPMorgan Securities is
required to
hold tentative net capital in excess of $1.0
billion and is also required to notify the
Securities and Exchange Commission (“SEC”) in the
event that tentative net capital is less than $5.0
billion in accordance with the market and credit
risk standards of Appendix E of the
Net Capital Rule. As of December 31, 2008, JPMorgan
Securities had tentative net capital in excess of
the minimum and the notification requirements. On
October 1, 2008, J.P. Morgan Securities Inc. merged
with and into Bear, Stearns & Co. Inc., and the
surviving entity changed its name to J.P. Morgan
Securities Inc.
J.P. Morgan Clearing Corp., a subsidiary of
JPMorgan Securities provides clearing and
settlement services. At December 31, 2008, J.P.
Morgan Clearing Corp.’s net capital, as defined by
the Net Capital Rule, of $4.7 billion exceeded the
minimum requirement by $3.3 billion.
Dividends
On
February 23, 2009, the Board of Directors reduced the
Firm’s quarterly common stock dividend from $0.38 to $0.05 per
share, effective for the dividend payable April 30, 2009 to
shareholders of record on April 6, 2009. JPMorgan Chase declared
quarterly cash dividends on its commons stock in the amount of $0.38
for each quarter of 2008 and the second, third and fourth quarters of
2007, and $0.34 per share for the first quarter of 2007 and for each
quarter of 2006.
The Firm’s common stock dividend policy
reflects JPMorgan Chase’s earnings outlook, desired
dividend payout ratios, need to maintain an
adequate capital level and alternative investment
opportunities. The Firm’s ability
to pay dividends is subject to restrictions. For
information regarding such restrictions, see page
72 and Note 24 and Note 29 on pages 193–194 and
199, respectively, of this Annual Report and for additional
information regarding the reduction of the dividend, see page 32.
The following table shows the common dividend
payout ratio based upon reported net income.
The Firm issued $6.0 billion and $1.8 billion
of noncumulative perpetual preferred stock on April23, 2008, and August 21, 2008, respectively.
Pursuant to the Capital Purchase Program, on
October 28, 2008, the Firm issued to the U.S.
Treasury $25.0 billion of cumulative preferred
stock and a warrant to purchase up to 88,401,697
shares of the Firm’s common stock. For additional
information regarding preferred stock, see Note 24
on pages 193–194 of this Annual Report.
On September 30, 2008, the Firm issued $11.5
billion, or 284 million shares, of common stock at
$40.50 per share. For additional information
regarding common stock, see Note 25 on pages
194–195 of this Annual Report.
Stock repurchases
During the year ended December 31, 2008, the
Firm did not repurchase any shares of its common
stock. During 2007, under the respective stock
repurchase programs then in effect, the Firm
repurchased 168 million shares for $8.2 billion at
an average price per share of $48.60.
The Board of Directors approved in April 2007, a
stock
repurchase program that authorizes the repurchase
of up to $10.0 billion of the Firm’s common shares,
which superseded an $8.0 billion stock repurchase
program approved in 2006. The $10.0 billion
authorization includes shares to be repurchased to
offset issuances under the Firm’s employee
stock-based plans. The actual number of shares that
may be repurchased is subject to various factors,
including market conditions; legal considerations
affecting the amount and timing of repurchase
activity; the Firm’s capital position (taking into
account goodwill and intangibles); internal capital
generation; and alternative potential investment
opportunities. The repurchase program does not
include specific price targets or timetables; may
be executed through open market purchases or
privately negotiated transactions, or utilizing
Rule 10b5-1 programs; and may be suspended at any
time. A Rule 10b5-1 repurchase plan allows the Firm
to repurchase shares during periods when it would
not otherwise be repurchasing common stock – for
example, during internal trading “black-out
periods.” All purchases under a Rule 10b5-1 plan
must be made according to a predefined plan that is
established when the Firm is not aware of material
nonpublic information.
As of December 31, 2008, $6.2 billion of
authorized repurchase capacity remained under
the current stock repurchase program.
For a discussion of restrictions on stock
repurchases, see Capital Purchase Program on page
72 and Note 24 on pages 193–194 of this Annual
Report.
For additional information regarding repurchases of
the Firm’s equity securities, see Part II, Item 5,
Market for registrant’s common equity, related
stockholder matters and issuer purchases of equity
securities, on page 17 of JPMorgan Chase’s 2008
Form 10-K.
Risk is an inherent part of JPMorgan Chase’s
business activities. The Firm’s risk management
framework and governance structure are intended to
provide comprehensive controls and ongoing
management of the major risks inherent in its
business activities. The Firm’s ability to properly
identify, measure, monitor and report risk is
critical to both its soundness and profitability.
•
Risk identification: The Firm’s exposure to risk through its daily business
dealings, including lending, trading and capital markets activities, is identified and
aggregated through the Firm’s risk management infrastructure. In addition, individuals who
manage risk positions, particularly those positions that are complex, are responsible for
identifying and estimating potential losses that could arise from specific or unusual
events, that may not be captured in other models, and those risks are communicated to
senior management.
•
Risk measurement: The Firm measures risk using a variety of methodologies, including
calculating probable loss, unexpected loss and value-at-risk, and by conducting stress
tests and making comparisons to external benchmarks. Measurement models and related
assumptions are routinely reviewed with the goal of ensuring that the Firm’s risk
estimates are reasonable and reflect underlying positions.
•
Risk monitoring/control: The Firm’s risk management policies and procedures
incorporate risk mitigation strategies and include approval limits by customer, product,
industry, country and business. These limits are monitored on a daily, weekly and monthly
basis, as appropriate.
•
Risk reporting: Risk reporting is executed on a line of business and consolidated
basis. This information is reported to management on a daily, weekly and monthly basis, as
appropriate. There are eight major risk types identified in the business activities of the
Firm: liquidity risk, credit risk, market risk, interest rate risk, private equity risk,
operational risk, legal and fiduciary risk, and reputation risk.
Risk governance
The Firm’s risk governance structure starts with
each line of business being responsible for
managing its own risks. Each line of business works
closely with Risk Management through its own risk
committee and, in most cases, its own chief risk
officer to manage risk. Each line of business risk
committee is responsible for decisions regarding
the business’ risk strategy, policies and controls.
Overlaying the line of business risk management are
four corporate functions with risk
management–related responsibilities: Treasury, the
Chief Investment Office, Legal and Compliance and
Risk Management.
Risk Management is headed by the Firm’s Chief Risk
Officer, who is a member of the Firm’s Operating
Committee and who reports to the Chief Executive
Officer and the Board of Directors, primarily
through the Board’s Risk Policy Committee. Risk
Management is responsible for providing a firmwide
function of risk management and controls. Within
Risk Management are units responsible for credit
risk, market risk, operational risk and private
equity risk, as well as Risk Management Services
and Risk Technology and Operations. Risk Management
Services is responsible for risk policy and
methodology, risk reporting and risk education; and
Risk Technology and Operations is responsible for
building
the information technology infrastructure used to
monitor and manage risk.
Treasury and the Chief Investment Office are
responsible for measuring, monitoring, reporting
and managing the Firm’s liquidity, interest rate
and foreign exchange risk.
Legal and Compliance has oversight for legal and fiduciary risk.
In addition to the risk committees of the lines of
business and the above-referenced corporate
functions, the Firm also has an Investment
Committee, ALCO and two other risk-related
committees, namely, the Risk Working Group and the
Markets Committee. The members of these committees
are composed of senior management of the Firm,
including representatives of line of business, Risk
Management, Finance and other senior executives.
Members of these risk committees meet frequently to
discuss a broad range of topics including, for
example, current market conditions and other
external events, current risk exposures and
concentrations to ensure that the impact of current
risk factors are considered broadly across the
Firm’s businesses.
The Investment Committee oversees global
merger and acquisition activities undertaken by
JPMorgan Chase for its own account that fall
outside the scope of the Firm’s private equity and
other principal finance activities.
The Asset-Liability Committee is responsible for
approving the Firm’s liquidity policy, including
contingency funding planning and exposure to SPEs
(and any required liquidity support by the Firm of
such SPEs). The Asset-Liability Committee also
oversees the Firm’s capital management and funds
transfer pricing policy (through which lines of
business “transfer” interest and foreign exchange
risk to Treasury in the Corporate/Private Equity
segment).
The Risk Working Group meets monthly to review
issues such as risk policy, risk methodology, Basel
II and regulatory issues and topics referred to it
by any line of business risk committee. The Markets
Committee, chaired by the Chief Risk Officer,
meets at least weekly to review and determine appropriate
courses of action with respect to significant risk
matters, including but not limited to: limits;
credit, market and operational risk; large, high
risk transactions; and hedging strategies.
The Board of Directors exercises its oversight of
risk management, principally through the Board’s
Risk Policy Committee and Audit Committee. The Risk
Policy Committee oversees senior management
risk-related responsibilities, including reviewing
management policies and performance against these
policies and related benchmarks. The Audit
Committee is responsible for oversight of
guidelines and policies that govern the process by
which risk assessment and management is undertaken.
In addition, the Audit Committee reviews
with management the system of internal controls and
financial reporting that is relied upon to provide
reasonable assurance of compliance with the Firm’s
operational risk management processes.
The ability to maintain a sufficient level
of liquidity is crucial to financial services
companies, particularly maintaining appropriate
levels of liquidity during periods of adverse
conditions. The Firm’s funding strategy is to
ensure liquidity and diversity of funding sources
to meet actual and contingent liabilities through
both stable and adverse conditions.
JPMorgan Chase uses a centralized approach for
liquidity risk management. Global funding is
managed by Corporate Treasury, using regional
expertise as appropriate. Management believes that
a centralized framework maximizes liquidity access,
minimizes funding costs and permits identification
and coordination of global liquidity risk.
Recent events
During the second half of 2008, global markets
exhibited extraordinary levels of volatility and
increasing signs of stress. Throughout this period,
access by market participants to the debt, equity,
and consumer loan securitization markets was
constrained and funding spreads widened sharply. In
response to strains in financial markets, U.S.
government and regulatory agencies introduced
various programs to inject liquidity into the
financial system. JPMorgan Chase participated in a
number of these programs, two of which were the
Capital Purchase Program and the FDIC’s TLG
Program. On October 28, 2008, JPMorgan Chase issued
$25.0 billion of preferred stock as well as a
warrant to purchase up to 88,401,697 shares of the
Firm’s common stock to the U.S. Treasury under the
Capital Purchase Program, which enhanced the Firm’s
capital and liquidity positions. In addition, on
December 4, 2008, JPMorgan Chase elected to
continue to participate in the FDIC’s TLG Program,
which facilitated long-term debt issuances at rates
(including the guarantee fee charged by the FDIC)
more favorable than those for non-FDIC guaranteed
debt issuances. Under the TLG Program, the FDIC
guarantees certain senior unsecured debt of
JPMorgan Chase, and in return for the guarantees,
the FDIC is paid a fee based on the amount and
maturity of the debt. Under the TLG Program, the
FDIC will pay the unpaid principal and interest on
an FDIC-guaranteed debt instrument upon the uncured
failure of the participating entity to make a
timely payment of principal or interest in
accordance with the terms of the instrument. During
the fourth quarter of 2008, pursuant to the TLG
Program, the Firm issued $20.8 billion of bonds
guaranteed by the FDIC, further enhancing the
Firm’s liquidity position. At December 31, 2008,
all of the FDIC-guaranteed debt
was outstanding and had a carrying value of $21.0
billion, net of hedges. In the interest of
promoting deposit stability, during the fourth
quarter, the FDIC also (i) temporarily increased,
through 2009, insurance coverage on bank deposits
to $250,000 per customer from $100,000 per
customer, and (ii) for qualified institutions who
participated in the TLG Program (such as the Firm),
provided full deposit insurance coverage for noninterest-bearing transaction accounts.
During the second half of 2008, the Firm’s
deposits (excluding those assumed in connection
with the Washington Mutual transaction) increased
substantially, as the Firm benefited from the
heightened volatility and credit concerns
affecting the markets.
On May 30, 2008, JPMorgan Chase completed the
merger with Bear Stearns. Due to the structure of
the transaction and the de-risking of positions
over time, the merger with Bear Stearns had no
material impact on the Firm’s liquidity. On
September 25, 2008, JPMorgan Chase acquired the
banking operations of Washington Mutual from the
FDIC. As part of the Washington Mutual transaction,
JPMorgan Chase assumed Washington Mutual’s deposits
as well as its obligations to its credit card
securitization-related master trusts, covered
bonds, and liabilities to certain Federal Home Loan
Banks. The Washington Mutual transaction had an
insignificant impact on the Firm’s overall
liquidity position.
Both S&P and Moody’s lowered the Firm’s ratings one
notch on December 19, 2008 and January 15, 2009,
respectively. These rating actions did not have a
material impact on the cost or availability of
funding to the Firm. For a further discussion of
credit ratings, see the Credit Ratings caption of
this Liquidity Risk Management section on pages 79-80 of
this Annual Report.
Notwithstanding the market events during the latter
half of 2008, the Firm’s liquidity position
remained strong based on its liquidity metrics as
of December 31, 2008. The Firm believes that its
unsecured and secured funding capacity is
sufficient to meet on- and off-balance sheet
obligations. JPMorgan Chase’s long-dated funding,
including core liabilities, exceeded illiquid
assets. In addition, during the course of 2008, the
Firm raised funds at the parent holding company in
excess of its minimum threshold to cover its
obligations and those of its nonbank subsidiaries
that mature over the next 12 months.
Governance
The Asset-Liability Committee approves and oversees
the execution of the Firm’s liquidity policy and
contingency funding plan. Corporate Treasury
formulates the Firm’s liquidity and contingency
planning strategies and is responsible for
measuring, monitoring, reporting and managing the
Firm’s liquidity risk profile.
Liquidity monitoring
The Firm monitors liquidity trends, tracks
historical and prospective on- and off-balance
sheet liquidity obligations, identifies and
measures internal and external liquidity warning
signals to permit early detection of liquidity
issues, and manages contingency planning
(including identification and testing of various
company-specific and market-driven stress
scenarios). Various tools, which together
contribute to an overall firmwide liquidity
perspective, are used to monitor and manage
liquidity. Among others, these include: (i)
analysis of the timing of liquidity sources versus
liquidity uses (i.e., funding gaps) over periods
ranging from overnight to one year; (ii) management
of debt and capital issuances to ensure that the
illiquid portion of the balance sheet can be funded
by equity, long-term debt, trust preferred capital
debt securities and deposits the Firm believes to
be stable; and (iii) assessment of the Firm’s
capacity to raise incremental unsecured and secured
funding.
Liquidity of the parent holding company and its
nonbank subsidiaries is monitored independently as
well as in conjunction with the liquidity
of the Firm’s bank subsidiaries. At the parent
holding company level, long-term funding is managed
to ensure that the parent holding company has, at a
minimum, sufficient liquidity to cover its
obligations and those of its nonbank subsidiaries
within the next 12 months. For bank subsidiaries,
the focus of liquidity risk management is on
maintenance of unsecured and secured funding
capacity sufficient to meet on- and off-balance
sheet obligations.
A component of liquidity management is the Firm’s
contingency funding plan. The goal of the plan is
to ensure appropriate liquidity during normal and
stress periods. The plan considers various
temporary and long-term stress scenarios where
access to unsecured funding is severely limited or
nonexistent, taking into account both on-and
off-balance sheet exposures, and separately
evaluates access to funds by the parent holding
company and the Firm’s banks.
Funding
Sources of funds
The deposits held by the RFS, CB, TSS and AM lines
of business are a generally consistent source of
funding for JPMorgan Chase Bank, N.A. As of
December 31, 2008, total deposits for the Firm were
$1.0 trillion, compared with $740.7 billion at
December 31, 2007. A significant portion of the
Firm’s deposits are retail deposits, which are less
sensitive to interest rate changes or market
volatility and therefore are considered more stable
than market-based (i.e., wholesale) liability
balances. The Washington Mutual transaction added
approximately $159.9 billion of deposits to the
Firm, a significant majority of which are retail
deposits. In addition, through the normal course of
business, the Firm benefits from substantial
liability balances originated by RFS, CB, TSS and AM.
These franchise-generated liability balances
include deposits and funds that are swept to
on-balance sheet liabilities (e.g., commercial
paper, federal funds purchased and securities
loaned or sold under repurchase agreements), a
significant portion of which are considered to be
stable and consistent sources of funding due to the
nature of the businesses from which
they are generated. For further discussions of
deposit and liability balance trends, see the
discussion of the results for the Firm’s business
segments and the Balance sheet analysis on pages
42–60 and 64–66, respectively, of this Annual
Report.
Additional sources of funding include a variety of
unsecured short-and long-term instruments,
including federal funds purchased, certificates of
deposits, time deposits, bank notes, commercial
paper, long-term debt, trust preferred capital debt
securities, preferred stock and common stock.
Secured sources of funding include securities
loaned or sold under repurchase agreements, asset
securitizations, borrowings from the Federal
Reserve (including discount window borrowings, the
Primary Dealer Credit Facility and the Term Auction
Facility) and borrowings from the Chicago,
Pittsburgh and, as a result of the Washington
Mutual transaction, the San Francisco Federal Home
Loan Banks. However, the Firm does not view
borrowings from the Federal Reserve as a primary
means of funding the Firm.
Issuance
Funding markets are evaluated on an ongoing basis
to achieve an appropriate global balance of
unsecured and secured funding at favorable rates.
Generating funding from a broad range of sources in
a variety of geographic locations enhances
financial flexibility and limits dependence on any
one source.
During 2008, JPMorgan Chase issued approximately
$42.6 billion of long-term debt for funding or
capital management purposes, including $20.8
billion of FDIC-guaranteed notes issued under the
TLG Program. The Firm also issued $28.0 billion of
IB structured notes, the issuances of which are
generally client-driven and not for funding or
capital management purposes, as the proceeds from
such transactions are generally used to purchase
securities to mitigate the risk associated with
structured note exposure. In addition, during the
year, the Firm issued $1.8 billion of trust
preferred capital debt securities. During the same
period, the Firm redeemed or had maturities of
$62.7 billion of securities, including $35.8
billion of IB structured notes.
Preferred stock issuances included $6.0 billion and
$1.8 billion of noncumulative perpetual preferred
stock issued on April 23 and August 21, 2008,
respectively, as well as preferred stock issued to
the U.S. Treasury on October 28, 2008, under the
Capital Purchase Program. In connection with
preferred stock issuance under the Capital Purchase
Program, the Firm also issued to the U.S. Treasury
on October 28, 2008, a warrant to purchase up to
88,401,697 shares of the Firm’s common stock, at an
exercise price of $42.42 per share, subject to
certain antidilution and other adjustments. The
Firm has in the past, and may continue in the
future, to repurchase from time to time its debt or
trust preferred capital debt securities in open
market purchases or privately negotiated
transactions subject to regulatory and contractual
restrictions.
Finally, during 2008, the Firm securitized $21.4
billion of credit card loans. The ability to
securitize loans, and the associated gains on those
securitizations, are principally
dependent upon the credit quality and other
characteristics of the assets securitized as well
as upon prevailing market conditions. Given the
volatility and stress in the financial markets in
the second half of 2008, the Firm did not
securitize any residential mortgage loans, auto
loans or student loans during 2008.
Replacement Capital Covenants
In connection with the issuance of certain of its
trust preferred capital debt securities and
noncumulative perpetual preferred stock, the Firm
entered into Replacement Capital Covenants (“RCCs”)
granting certain rights to the holders of “covered
debt,” as defined in the RCCs, that prohibit the
repayment, redemption or purchase of the trust
preferred capital debt securities and noncumulative
perpetual preferred stock except, with limited
exceptions, to the extent that JPMorgan Chase has
received, in each such case, specified amounts of
proceeds from the sale of certain qualifying
securities. Currently the Firm’s covered debt is
its 5.875% Junior Subordinated Deferrable Interest
Debentures, Series O, due in 2035. For more
information regarding these covenants, reference is
made to the respective RCCs entered into by the
Firm in connection with the issuances of such trust
preferred capital debt securities and noncumulative
perpetual
preferred stock, which are filed with the U.S.
Securities and Exchange Commission under cover of
Forms 8-K.
Cash flows
For the years ended December 31, 2008, 2007 and
2006, cash and due from banks decreased $13.2
billion, $268 million, and increased
$3.7 billion, respectively. The following
discussion highlights the major activities and
transactions that affected JPMorgan Chase’s cash
flows during 2008, 2007 and 2006.
Cash Flows from Operating Activities
JPMorgan Chase’s operating assets and liabilities
support the Firm’s capital markets and lending
activities, including the origination or purchase
of loans initially designated as held-for-sale.
The operating assets and liabilities can vary
significantly in the normal course of business due
to the amount and timing of cash flows, which are
affected by client-driven activities, market
conditions and trading strategies. Management
believes cash flows from operations, available
cash balances and the Firm’s ability to generate
cash through short-and long-term borrowings are
sufficient to fund the Firm’s operating liquidity
needs.
For the year ended December 31, 2008, net cash
provided by operating activities was $23.1 billion,
while for the years ended December 31, 2007 and
2006, net cash used in operating activities was
$110.6 billion and $49.6 billion, respectively. In
2008, net cash generated from operating activities
was higher than net income,
largely as a result of adjustments for operating
items such as the provision for credit losses,
depreciation and amortization, stock-based
compensation, and certain other expense. During
2006, 2007 and 2008,
cash was used to fund loans held-for-sale,
primarily in IB and RFS. During 2008, proceeds
from sales of loans originated or purchased with an
initial intent to sell were slightly higher than
cash used to acquire such loans; but the cash flows
from these activities were at a significantly lower
level than for the same periods in 2007 and 2006 as
a result of current market conditions. In 2007 and
2006, cash used to acquire such loans was slightly
higher than proceeds from sales.
For the years ended December 31, 2007 and 2006, the
net cash used in operating activities supported
growth in the Firm’s lending and capital markets
activities. In 2007, when compared with 2006, there
was a significant decline in cash flows from IB
loan originations/purchases and sale/securitization
activities as a result of the difficult wholesale
securitization market and capital markets for
leveraged financings, which were affected by a
significant deterioration in liquidity in the
second half of 2007. Cash flows in 2007 associated
with RFS residential mortgage activities grew,
reflecting an increase in originations.
Cash Flows from Investing Activities
The Firm’s investing activities predominantly
include originating loans to be held for investment,
other receivables, the available-for-sale
investment portfolio and other short-term
investment vehicles. For the year ended December31, 2008, net cash of $286.3 billion was used in
investing activities, primarily for: purchases of
investment securities in Corporate’s AFS portfolio
to manage the Firm’s exposure to interest
rate movements, as well as to make strategic
longer-term investments; increased deposits with
banks as the result of the availability of excess
cash for short-term investment opportunities
through inter-bank lending, and from deposits with
the Federal Reserve (which is now an investing
activity, reflecting a policy change of the Federal
Reserve to pay interest to depository institutions
on reserve balances); net additions to the
wholesale loan portfolio, from organic growth in
CB; additions to the consumer prime mortgage
portfolio as a result of the decision to retain,
rather than sell, new originations of nonconforming
prime mortgage loans; an increase in securities
purchased under resale agreements reflecting growth
in demand from clients for liquidity; and net
purchases of asset-backed commercial paper from
money market mutual funds in connection with a
temporary Federal Reserve Bank of Boston lending
facility. Partially offsetting these uses of cash
were proceeds from sales and maturities of AFS
securities; loan sales and credit card
securitization activities, which were at a lower
level than for the same periods in 2007 as a result
of the adverse market conditions that have
continued since the last half of 2007; and net cash
received from acquisitions and the sale of an
investment. Additionally, in June 2008, in
connection with the merger
with Bear Stearns, the Firm sold assets acquired
from Bear Stearns to the FRBNY and received cash
proceeds of $28.85 billion (for additional
information see Note 2 on page 123–128 of this
Annual Report).
For the year ended December 31, 2007, net cash of
$73.1 billion was used in investing activities,
primarily to fund purchases in the AFS securities
portfolio to manage the Firm’s exposure to interest
rate movements; net additions to the wholesale
retained loan portfolios in IB, CB and AM, mainly
as a result of business growth; a net increase in
the consumer retained loan portfolio, primarily
reflecting growth in RFS in home equity loans and
net additions to RFS’ subprime mortgage loans
portfolio (which was affected by management’s
decision in the third quarter to retain (rather
than sell) new subprime mortgages), and growth in
prime mortgage loans originated by RFS and AM that
cannot be sold to U.S. government agencies or U.S.
government-sponsored enterprises; and increases in
securities purchased under resale agreements as a
result of a higher level of cash that was available
for short-term investment opportunities in
connection with the Firm’s efforts to build
liquidity. These net uses of cash were partially
offset by cash proceeds received from sales and
maturities of AFS securities; and credit card,
residential mortgage, student and wholesale loan
sales and securitization activities, which grew in
2007 despite the difficult conditions in the credit
markets.
For the year ended December 31, 2006, net cash of
$99.6 billion was used in investing activities. Net
cash was invested to fund net additions to the
retained wholesale loan portfolio, mainly resulting
from capital markets activity in IB leveraged
financings; increases in CS loans reflecting strong
organic growth; net additions in retail home equity
loans; the acquisition of private-label credit card
portfolios from Kohl’s, BP and Pier 1 Imports,
Inc.; the acquisition of Collegiate Funding
Services; and purchases of AFS securities in
connection with repositioning the portfolio in
response to changes in interest rates. These uses
of cash were partially offset by cash proceeds
provided from credit card, residential mortgage,
auto and
wholesale loan sales and securitization
activities; sales and maturities of AFS
securities; the net decline in auto loans, which
was caused partially by management’s decision to
de-emphasize vehicle leasing; and the sale of the
insurance business at the beginning of the second
quarter.
Cash Flows from Financing Activities
The Firm’s financing activities primarily reflect
cash flows related to customer deposits, issuances
of long-term debt and trust preferred capital debt
securities, and issuances of preferred and common
stock. In 2008, net cash provided by financing
activities was $250.5 billion due to: growth in
wholesale deposits, in particular, interest-and
noninterest-bearing deposits in TSS (driven by both
new and existing clients, and due to the deposit
inflows related to the heightened volatility and
credit
concerns affecting the global markets), as well as
increases in AM and CB (due to organic growth);
proceeds of
$25.0 billion from the issuance of preferred stock
and a warrant to the U.S. Treasury under the
Capital Purchase Program; additional issuances of
common stock and preferred stock used for general
corporate purposes; an increase in other borrowings
due to nonrecourse secured advances from the
Federal Reserve Bank of Boston to fund the purchase
of asset-backed commercial paper from money market
mutual funds; increases in federal funds purchased
and securities loaned or sold under repurchase
agreements in connection with higher short-term
requirements to fulfill client demand for liquidity
and finance the Firm’s AFS securities inventory;
and a net increase in long-term debt due to a
combination of non-FDIC guaranteed debt and trust
preferred capital debt securities issued prior to
December4, 2008, and the issuance of $20.8 billion of
FDIC-guaranteed long-term debt issued during the
fourth quarter of 2008. The fourth-quarter
FDIC-guaranteed issuance was offset partially by
maturities of non-FDIC guaranteed long-term debt
during the same period. The increase in long-term
debt and trust preferred capital debt securities
was used primarily to fund certain illiquid assets
held by the parent holding company and build
liquidity. Cash was also used to pay dividends on
common and preferred stock. The Firm did not
repurchase any shares of its common stock in the
open market during 2008 in order to maintain its
capital objectives.
In 2007, net cash provided by financing activities
was $183.0 billion due to a net increase in
wholesale deposits from growth in business volumes,
in particular, interest-bearing deposits at TSS, AM
and CB;
net issuances of long-term debt and trust preferred
capital debt securities primarily to fund certain
illiquid assets held by the parent holding company
and build liquidity, and by IB from client-driven
structured notes transactions; and growth in
commercial paper issuances and other borrowed funds
due to growth in the volume of liability balances
in sweep accounts in TSS and CB, and to fund
trading positions and to further build liquidity.
Cash was used to repurchase common stock and pay
dividends on common stock, including an increase in
the quarterly dividend in the second quarter of
2007.
In 2006, net cash provided by financing activities
was $152.7 billion due to net cash received from
growth in deposits, reflecting new retail account
acquisitions and the ongoing expansion of the
retail branch distribution network; higher
wholesale business volumes; increases in securities
sold under repurchase agreements to fund trading
positions and higher AFS securities positions; and
net issuances of long-term debt and trust preferred
capital debt securities. The net cash provided was
offset partially by the payment of cash dividends
on stock and common stock repurchases.
Credit ratings
The cost and availability of financing are
influenced by credit ratings. Reductions in these
ratings could have an adverse effect on the Firm’s
access to liquidity sources, increase the cost of
funds, trigger additional collateral or funding
requirements and decrease the number of investors
and counterparties willing to lend to the Firm.
Additionally, the Firm’s funding requirements for
VIEs and other third-party commitments may be
adversely affected. For additional information on
the impact of a credit ratings downgrade on the
funding requirements for VIEs, and on derivatives
and collateral agreements, see Special-purpose
entities on pages 67–68 and Ratings profile of
derivative receivables marked to market (“MTM”) on
page 88 of this Annual Report.
Critical factors in maintaining high credit ratings
include a stable and diverse earnings stream,
strong capital ratios, strong credit quality and
risk management controls, diverse funding sources,
and disciplined liquidity monitoring procedures.
The credit ratings of the parent holding company and each of the Firm’s significant banking
subsidiaries as of January 15, 2009, were as follows.
On December 19, 2008, S&P lowered the senior
long-term debt ratings on JPMorgan Chase & Co. and
its principal bank subsidiaries one notch from
“AA-” and “AA”, respectively; lowered the
short-term debt rating of JPMorgan Chase & Co. from
“A-1+”; and affirmed the short-term debt ratings of
its principal bank subsidiaries. These actions were
primarily the result of S&P’s belief that the
Firm’s earnings are likely to decline over the next
couple of years in response to increasing loan
losses associated with the Firm’s exposure to
consumer lending, as well as declining business
volumes. S&P’s current outlook is negative. On
January 15, 2009, Moody’s lowered the senior
long-term debt ratings on JPMorgan Chase & Co. and
its principal bank subsidiaries from “Aa2” and
“Aaa”, respectively. These actions were primarily
the result of Moody’s view that, in the current
economic environment, the Firm may experience
difficulties generating capital and could face
significant earnings pressure. Moody’s affirmed the
short-term debt ratings of JPMorgan Chase &
Co. and its principal bank subsidiaries at “P-1”.
Moody’s also revised the outlook to stable from
negative due to the Firm’s strong capital ratios,
significant loan loss reserves, and strong
franchise. Ratings from Fitch on JPMorgan Chase &
Co. and its principal bank subsidiaries remained
unchanged from December 31, 2007, and Fitch’s
outlook remained stable. The recent rating actions
by S&P and Moody’s did not have a material impact
on the cost or availability of the Firm’s funding. If the
Firm’s senior long-term debt ratings were
downgraded by one additional notch, the Firm
believes the incremental cost of funds or loss of funding would be
manageable within the context of current market conditions and the
Firm’s liquidity resources. JPMorgan Chase’s unsecured
debt, other than in certain cases the IB structured notes, does not contain requirements that would call
for an acceleration of payments, maturities or
changes in the structure of the existing debt, nor
contain collateral provisions or the creation of an
additional financial obligation, based on
unfavorable changes in the Firm’s credit ratings,
financial ratios, earnings, cash flows or stock
price. To the extent any IB structured notes do contain such
provisions, the Firm believes that, in the event of an acceleration
of payments or maturities or provision of collateral, the securities
used by the Firm to risk manage such structured notes, together with
other liquidity resources, are expected to generate funds sufficient
to satisfy the Firm’s obligations.
CREDIT RISK MANAGEMENT
Credit risk is the risk of loss from obligor or
counterparty default. The Firm provides credit (for
example, through loans, lending-related commitments
and derivatives) to a variety of customers, from
large corporate and institutional clients to the
individual consumer. For the wholesale business,
credit risk management includes the distribution of
syndicated loans originated by the Firm into the
marketplace (primarily to IB clients), with
exposure held in the retained portfolio averaging
less than 10% of the total originated loans.
Wholesale loans generated by CB and AM are
generally retained on the balance sheet. With
regard to the consumer credit market, the Firm
focuses on creating a portfolio that is diversified
from both a product and a geographic perspective.
Loss mitigation strategies are being employed for all
home lending portfolios. These strategies include
rate reductions, principal forgiveness, forbearance
and other actions intended to minimize the economic
loss and avoid foreclosure. In the mortgage
business, originated loans are either retained in
the mortgage portfolio or securitized and sold to
U.S. government agencies and U.S. government-sponsored enterprises.
Credit risk organization
Credit risk management is overseen by the Chief
Risk Officer and implemented within the lines of
business. The Firm’s credit risk management
governance consists of the following functions:
•
establishing a comprehensive credit risk policy framework
•
monitoring and managing credit risk across all portfolio segments, including
transaction and line approval
•
assigning and managing credit authorities in connection with the approval of all
credit exposure
•
managing criticized exposures
•
calculating the allowance for credit losses and ensuring appropriate credit
risk-based capital management
Risk identification
The Firm is exposed to credit risk through lending
and capital markets activities. The credit risk
management organization works in partnership with the
business segments in identifying and aggregating
exposures across all lines of business.
Risk measurement
To measure credit risk, the Firm employs several
methodologies for estimating the likelihood of
obligor or counterparty default. Methodologies for
measuring credit risk vary depending on several
factors, including type of asset (e.g., consumer
installment versus wholesale loan), risk
measurement parameters (e.g., delinquency status
and credit bureau score versus wholesale risk
rating) and risk management and collection
processes (e.g., retail collection center versus
centrally managed workout groups). Credit risk
measurement is based upon the amount of exposure
should the obligor or the counterparty default, the
probability of default and the loss severity given
a default event. Based upon these factors and
related market-based inputs, the Firm estimates
both probable and unexpected losses for the
wholesale and consumer portfolios. Probable losses,
reflected in the provision for credit losses, are
based primarily upon statistical estimates of
credit losses as a result of obligor or
counterparty default. However, probable losses are
not the sole indicators of risk. If losses were
entirely predictable, the probable loss rate could
be factored into pricing and covered as a normal
and recurring cost of doing business. Unexpected
losses, reflected in the allocation of credit risk
capital, represent the potential volatility of
actual losses relative to the probable level of
losses. Risk measurement for the wholesale
portfolio is assessed primarily on a risk-rated
basis; for the consumer portfolio, it is assessed
primarily on a credit-scored basis.
Risk-rated exposure
For portfolios that are risk-rated (generally held
in IB, CB, TSS and AM), probable and unexpected
loss calculations are based upon estimates of
probability of default and loss given default.
Probability of default is the expected default
calculated on an obligor basis. Loss given default
is an estimate of losses given a default event and
takes into consideration collateral and structural
support for each credit facility. Calculations and
assumptions are based upon management information
systems and methodologies which are under continual
review. Risk ratings are assigned to differentiate
risk within the portfolio and are reviewed on an
ongoing basis by credit risk management and
revised, if needed, to reflect the borrowers’
current risk profiles and the related collateral
and structural positions.
Credit-scored exposure
For credit-scored portfolios (generally held in RFS
and CS), probable loss is based upon a statistical
analysis of inherent losses over discrete periods
of time. Probable losses are estimated using
sophisticated portfolio modeling, credit scoring
and decision-support tools to project credit risks
and establish underwriting standards. In addition,
common measures of credit quality derived from
historical loss experience are used to predict
consumer losses. Other risk characteristics
evaluated include recent loss experience in the
portfolios, changes in origination sources,
portfolio seasoning, loss severity and underlying
credit practices, including charge-off policies.
These analyses are applied to the Firm’s current
portfolios in order to estimate delinquencies and
severity of losses, which determine the amount of
probable losses. These factors and analyses are
updated at least on a quarterly basis or more
frequently as market conditions dictate.
Risk monitoring
The Firm has developed policies and practices that
are designed to preserve the independence and
integrity of the approval and decision making of
extending credit and are intended to ensure credit
risks are assessed accurately, approved properly,
monitored regularly and managed actively at both
the transaction and portfolio levels. The policy
framework establishes credit approval authorities,
concentration limits, risk-rating methodologies,
portfolio review parameters and guidelines for
management of distressed exposure. Wholesale credit
risk is monitored regularly on both an aggregate
portfolio level and on an individual customer
basis. Management of the Firm’s wholesale exposure
is accomplished through a number of means including
loan syndication and participations, loan sales,
securitizations, credit derivatives, use of master
netting agreements and collateral and other
risk-reduction techniques, which are further
discussed in the following risk sections. For
consumer credit risk, the key focus items are
trends and concentrations at the portfolio level,
whereby potential problems can be remedied through
changes in underwriting policies and portfolio
guidelines. Consumer Credit Risk Management
monitors trends against business expectations and
industry benchmarks.
Risk reporting
To enable monitoring of credit risk and
decision-making, aggregate credit exposure, credit
quality forecasts, concentrations levels and risk
profile changes are reported regularly to senior
credit risk management. Detailed portfolio
reporting of industry, customer and geographic
concentrations occurs monthly, and the
appropriateness of the allowance for credit losses
is reviewed by senior management at least on a
quarterly basis. Through the risk reporting and
governance structure, credit risk trends and limit
exceptions are provided regularly to, and discussed
with, senior management, for further information,
see page 74 of this Annual Report.
2008 Credit risk overview
During 2008, credit markets experienced
deterioration and increased defaults and downgrades
reflecting,
among other things, reduced liquidity. The
liquidity and credit crisis has adversely affected
many financial institutions, resulting in the
failure of some in both the U.S. and Europe, and
has impacted the functioning of credit markets,
particularly, the loan syndication and asset-backed
securitization markets. The Firm’s credit portfolio
was affected by these market conditions and
experienced deteriorating credit quality,
especially in the latter part of the year,
generally consistent with the market. In 2008, for
the wholesale portfolio, criticized assets and NPAs
increased, from historical lows, 301% and 525%,
respectively, from the previous year. Charge-offs,
which typically lag other portfolio deterioration,
have increased from historical lows by 458% over
2007. The Firm has remained focused on aggressively
managing the portfolio, including ongoing, in-depth
reviews of credit quality, as well as of revisions
of industry, product and client concentrations.
Risk levels are adjusted as needed to reflect the
Firm’s risk tolerance.
Underwriting standards across all areas of lending
have been strengthened, consistent with evolving
market conditions in order to permit the Firm to
lend in a safe and prudent manner. In light of the
current market conditions, the wholesale allowance
for loan loss coverage ratio has been strengthened
to 2.64%, from 1.67% at the end of 2007.
Consumer portfolio credit performance continues to
be negatively affected by the economic environment,
particularly the weak labor market and the decline
in housing prices which occurred nationally. As a
result, the Firm took actions throughout the year
to reduce risk exposure by tightening underwriting
and loan qualification standards in those markets
most affected by the housing downturn. In the
fourth quarter of 2008, the Firm announced plans to
significantly expand loss mitigation efforts
related to its mortgage and home equity portfolios.
During the implementation period of these expanded
loss mitigation efforts, which was substantially in
place in early 2009, the Firm did not place loans
into foreclosure. These loss mitigation efforts are
expected to result in additional increases in the
balance of modified loans carried on the Firm’s
balance sheet, including loans accounted for as
troubled debt restructurings, while minimizing the
economic loss to the Firm and assisting homeowners
to remain in their homes.
More detailed discussion of the domestic consumer
credit environment can be found on pages 91–92
of this Annual Report.
The following table presents JPMorgan Chase’s
credit portfolio as of December 31, 2008 and 2007.
Total credit exposure at December 31, 2008,
increased $198.8 billion from December 31, 2007,
reflecting an increase of $115.0 billion in the
consumer credit portfolio and $83.8 billion in the
wholesale credit portfolio. The increase in total
credit exposure from the prior year reflects $319.2
billion and $54.3 billion of additional credit exposure acquired in
connection with the Washington Mutual and Bear Stearns transactions,
respectively.
The exposure from the Washington Mutual transaction consisted of $271.7 billion in the
consumer portfolio and $47.5 billion in the
wholesale portfolio, which was primarily commercial
lending. The exposure from the Bear Stearns acquisition was included
in the wholesale portfolio. Excluding these two
transactions, there was a decrease of $174.7 billion
in overall credit exposure, which was largely
driven by decreases in lending-related commitments,
partly offset by increases in derivative
receivables and managed loans.
While overall portfolio exposure declined when
excluding the Washington Mutual and Bear Stearns
transactions, the Firm provided over $150 billion
in new loans and lines of credit to retail and
wholesale clients in the fourth quarter of 2008,
including individual consumers, small businesses,
large corporations, not-for-profit organizations,
states and municipalities, and other financial
institutions.
In the table below, reported loans include loans
accounted for at fair value and loans
held-for-sale, which are carried at lower of cost
or fair value, with changes in value recorded in
noninterest revenue. However, these held-for-sale
loans and loans accounted for at fair value are
excluded from the average loan balances used for
the net charge-off rate calculations.
Total credit portfolio
Nonperforming
90 days past due
Average annual
As of or for the year ended December 31,
Credit exposure
assets(h)(i)(j)(k)
and still accruing
Net charge-offs
net charge-off rate
(in millions, except ratios)
2008
2007
2008
2007
2008
2007
2008
2007
2008
2007
Total credit portfolio
Loans retained(a)
$
728,915
$
491,736
$
8,921
(j)
$
3,232
(j)
$
3,275
$
2,043
$
9,835
$
4,538
1.73
%
1.00
%
Loans held-for-sale
8,287
18,899
12
45
—
—
—
—
—
NA
Loans at fair value
7,696
8,739
20
5
—
—
—
—
—
NA
Loans – reported(a)
$
744,898
$
519,374
$
8,953
$
3,282
$
3,275
$
2,043
$
9,835
$
4,538
1.73
%
1.00
%
Loans – securitized(b)
85,571
72,701
—
—
1,802
1,050
3,612
2,380
4.53
3.43
Total managed loans
830,469
592,075
8,953
3,282
5,077
3,093
13,447
6,918
2.08
1.33
Derivative receivables
162,626
77,136
1,079
29
—
—
NA
NA
NA
NA
Receivables from customers(c)
16,141
—
—
—
—
—
NA
NA
NA
NA
Total managed credit-related assets
1,009,236
669,211
10,032
3,311
5,077
3,093
13,447
6,918
2.08
1.33
Lending-related commitments(d)(e)
1,121,378
1,262,588
NA
NA
NA
NA
NA
NA
NA
NA
Assets acquired in loan satisfactions
Real estate owned
NA
NA
2,533
(k)
546
NA
NA
NA
NA
NA
NA
Other
NA
NA
149
(k)
76
NA
NA
NA
NA
NA
NA
Total assets acquired in loan
satisfactions
NA
NA
2,682
622
NA
NA
NA
NA
NA
NA
Total credit portfolio
$
2,130,614
$
1,931,799
$
12,714
$
3,933
$
5,077
$
3,093
$
13,447
$
6,918
2.08
%
1.33
%
Net credit derivative hedges
notional(f)
$
(91,451
)
$
(67,999
)
$
—
$
(3
)
NA
NA
NA
NA
NA
NA
Collateral held against
derivatives(g)
(19,816
)
(9,824
)
NA
NA
NA
NA
NA
NA
NA
NA
(a)
Loans (other than those for which the SFAS 159 fair value option has been elected) are
presented net of unearned income and net deferred loan fees of $694 million and $1.0
billion at December 31, 2008 and 2007, respectively.
(b)
Represents securitized credit card receivables. For further discussion of credit card
securitizations, see Card Services on pages 51–53 of this Annual Report.
(c)
Primarily represents margin loans to prime and retail brokerage customers included in
accrued interest and accounts receivable on the Consolidated Balance Sheets.
(d)
Includes credit card and home equity lending-related commitments of $623.7 billion
and $95.7 billion, respectively, at December 31, 2008, and $714.8 billion and $74.2
billion, respectively, at December 31, 2007. These amounts for credit card and home equity
lending-related commitments represent the total available credit for these products. The
Firm has not experienced, nor does it anticipate, all available lines of credit being used
at the same time. The Firm can reduce or cancel these lines of credit by providing the
borrower prior notice or, in some cases, without notice as permitted by law.
(e)
Includes unused advised lines of credit totaling $36.3 billion and $38.4 billion at
December 31, 2008 and 2007, respectively, which are not legally binding. In regulatory
filings with the Federal Reserve, unused advised lines are not reportable. See the
Glossary of Terms on page 218 of this Annual Report for the Firm’s definition of advised
lines of credit.
(f)
Represents the net notional amount of protection purchased and sold of single-name
and portfolio credit derivatives used to manage the credit exposures; these derivatives do
not qualify for hedge accounting under SFAS 133. For additional
information, see page 89
of this Annual Report.
(g)
Represents other liquid securities collateral held by the Firm as of December 31,2008 and 2007, respectively.
(h)
Excludes nonperforming assets related to (1) loans eligible for repurchase as well as
loans repurchased from GNMA pools that are insured by U.S. government agencies of $3.3
billion and $1.5 billion at December 31, 2008, and 2007, respectively, and (2) student
loans that are 90 days past due and still accruing, which are insured by U.S. government
agencies under the Federal Family Education Loan Program, of $437 million and $417 million
at December 31, 2008 and 2007, respectively. These amounts for GNMA and student loans are
excluded, as reimbursement is proceeding normally.
(i)
During the second quarter of 2008, the policy for classifying subprime mortgage and
home equity loans as nonperforming was changed to conform to all other home lending
products. Amounts for 2007 have been revised to reflect this change.
(j)
Excludes home lending purchased credit-impaired home loans accounted for under SOP
03-3 that were acquired as part of the Washington Mutual transaction. These loans are
accounted for on a pool basis and the pools are considered to be performing under SOP
03-3. Also excludes loans held-for-sale and loans at fair value.
(k)
Includes $1.5 billion of assets acquired in the Washington Mutual transaction.
As of December 31, 2008, wholesale exposure
(IB, CB, TSS and AM) increased $83.8 billion from
December 31, 2007, primarily due to the Bear
Stearns merger, which added $54.3 billion of wholesale exposure in the
second quarter of 2008 ($26.0 billion of
receivables from customers, $18.9 billion of
derivative receivables, $5.0 billion of
lending-related commitments and $4.4 billion of
loans) and the Washington Mutual transaction (which
added $47.5 billion of wholesale exposure in the third
quarter of 2008, mainly consisting of loans).
Excluding these two transactions,
the portfolio decreased $18.0 billion, largely
driven by decreases of $73.7 billion in
lending-related commitments and $9.9 billion in
receivables from customers. Partly offsetting these
decreases was an increase of $65.5 billion in
derivative receivables. The decrease in
lending-related commitments was largely related to
a reduction in multi-seller conduit-related
commitments. The increase in derivative receivables
was primarily related to the decline in interest
rates, widening credit spreads and volatile foreign
exchange rates reflected in interest rate, credit
and foreign exchange derivatives, respectively. For
additional information regarding conduit-related
commitments, see Note 17 on pages 177–186 of this
Annual Report.
Excluding the Washington Mutual and Bear Stearns
transactions, retained loans increased $11.0
billion reflecting increases in traditional lending activity while loans held-for-sale and loans at fair
value decreased reflecting sales, reduced carrying values
and lower volumes in the syndication market.
Wholesale
90 days past due
As of or for the year ended December 31,
Credit exposure
Nonperforming loans(f)
and accruing
(in millions)
2008
2007
2008
2007
2008
2007
Loans retained(a)
$
248,089
$
189,427
$
2,350
$
464
$
163
$
75
Loans held-for-sale
6,259
14,910
12
45
—
—
Loans at fair value
7,696
8,739
20
5
—
—
Loans – reported
$
262,044
$
213,076
$
2,382
$
514
$
163
$
75
Derivative receivables
162,626
77,136
1,079
29
—
—
Receivables from customers(b)
16,141
—
—
—
—
—
Total wholesale credit-related assets
440,811
290,212
3,461
543
163
75
Lending-related commitments(c)
379,871
446,652
NA
NA
NA
NA
Total wholesale credit exposure
$
820,682
$
736,864
$
3,461
$
543
$
163
$
75
Credit derivative hedges notional(d)
$
(91,451
)
$
(67,999
)
$
—
$
(3
)
NA
NA
Collateral held against derivatives(e)
(19,816
)
(9,824
)
NA
NA
NA
NA
(a)
Includes $224 million of purchased credit-impaired loans at December 31, 2008, which
are accounted for in accordance with SOP 03-3. They are considered nonperforming loans
because the timing and amount of expected future cash flows is not reasonably estimable.
For additional information, see Note 14 on pages 163–166 of this Annual Report.
(b)
Primarily represents margin loans to prime and retail brokerage customers, which are
included in accrued interest and accounts receivable on the Consolidated Balance Sheets.
(c)
Includes unused advised lines of credit totaling $36.3 billion and $38.4 billion at
December 31, 2008 and 2007, respectively, which are not legally binding. In regulatory
filings with the Federal Reserve, unused advised lines are not reportable.
(d)
Represents the net notional amount of protection purchased and sold of single-name
and portfolio credit derivatives used to manage the credit exposures; these derivatives do
not qualify for hedge accounting under SFAS 133. For additional information, see page 89
of this Annual Report.
(e)
Represents other liquid securities collateral held by the Firm as of December 31,2008 and 2007, respectively.
(f)
Assets acquired in loan satisfactions have been excluded in this presentation. See
the wholesale nonperforming assets by line of business segment table for additional
information.
The following table presents net charge-offs
(excluding gains from sales of nonperforming
loans), for the years ended December 31, 2008 and
2007.
Net charge-offs
Wholesale
Year ended December 31,
(in millions, except ratios)
2008
2007
Loans – reported
Net charge-offs
$
402
$
72
Average annual net charge-off rate(a)
0.18
%
0.04
%
(a)
Excludes average wholesale loans held-for-sale and loans at fair value of $18.9 billion
and $18.6 billion for the years ended December 31, 2008 and 2007, respectively.
The following table presents the change in the
wholesale nonperforming loan portfolio for the
years ended December 31, 2008 and 2007.
The following table presents the wholesale nonperforming assets by business segment as of
December 31, 2008 and 2007.
2008
2007
Assets acquired in
Assets acquired in
loan satisfactions
loan satisfactions
As of December 31,
Nonperforming
Real estate
Nonperforming
Nonperforming
Real estate
Nonperforming
(in millions)
loans
owned
Other
assets
loans
owned
Other
assets
Investment Bank
$
1,175
$
247
$
1,079
(a)
$
2,501
$
353
$
67
$
33
(a)
$
453
Commercial Banking
1,026
102
14
1,142
146
2
—
148
Treasury &
Securities
Services
30
—
—
30
—
—
—
—
Asset Management
147
—
25
172
12
—
—
12
Corporate/Private
Equity
4
—
—
4
3
—
—
3
Total
$
2,382
$
349
$
1,118
$
3,849
$
514
$
69
$
33
$
616
(a)
Includes derivative receivables of $1.1 billion and $29 million as of December 31, 2008 and
2007, respectively.
The following table presents summaries of the maturity and ratings profiles of the wholesale
portfolio as of December 31, 2008 and 2007. The increase in the proportion of loans maturing after
five years was predominantly due to the Washington Mutual transaction. The ratings scale is based
upon the Firm’s internal risk ratings and generally correspond to the ratings as defined by S&P and
Moody’s.
Wholesale credit exposure – maturity and ratings profile
Total excluding loans
held-for-sale and
loans at fair value
36
%
53
%
11
%
100
%
$
571
$
142
713
80
%
Loans held-for-sale and
loans at fair value(a)
24
Total exposure
$
737
Net credit derivative
hedges notional(b)
39
%
56
%
5
%
100
%
$
(68
)
$
—
$
(68
)
100
%
(a)
Loans held-for-sale and loans at fair value relate primarily to syndicated loans and loans transferred from
the retained portfolio.
(b)
Represents the net notional amounts of protection purchased and sold of single-name
and portfolio credit derivatives used to manage the credit exposures; these derivatives do
not qualify for hedge accounting under SFAS 133.
(c)
The maturity profile of loans and lending-related commitments is based upon the
remaining contractual maturity. The maturity profile of derivative receivables is based
upon the maturity profile of average exposure. See page 87 of this Annual Report for a
further discussion of average exposure.
Wholesale credit exposure – selected industry concentration
The Firm focuses on the management and
diversification of its industry concentrations,
with particular attention paid to industries with
actual or potential credit concerns. At December31, 2008, the top 15 industries to which the Firm
is exposed remained largely unchanged from December31, 2007. The Firm’s real estate industry exposure
increased from the prior year due to the Washington
Mutual transaction. Customer receivables
of $16.1 billion in the table below represents primarily margin
loans to prime and retail brokerage clients acquired in the Bear Stearns merger. These
margin loans are generally fully collateralized by
cash or highly liquid securities to satisfy daily
minimum collateral requirements. For additional
information on industry concentrations, see Note 34
on pages 210–211 of this Annual Report.
Wholesale credit exposure – selected industry concentration
Rankings are based upon exposure at December 31, 2008. The industries presented in
2007 table reflect the rankings in the 2008 table.
(b)
For more information on exposures to SPEs included in all other, see Note 17 on
pages 177–186 of this Annual Report.
(c)
Loans held-for-sale and loans at fair value relate primarily to syndicated loans and loans transferred
from the retained portfolio.
(d)
Credit exposure is net of risk participations and excludes the benefit of credit
derivative hedges and collateral held against derivative receivables or loans.
(e)
Represents the net notional amounts of protection purchased and sold of single-name and portfolio credit derivatives used to manage the credit exposures; these
derivatives do not qualify for hedge accounting under SFAS 133.
(f)
Represents other liquid securities collateral held by the Firm as of December 31,2008 and 2007, respectively.
Wholesale criticized exposure
Exposures deemed criticized generally represent a
ratings profile similar to a rating of
“CCC+"/“Caa1” and lower, as defined by S&P and
Moody’s. The total criticized component of the
portfolio, excluding loans held-for-sale and loans
at fair value, increased to $26.0 billion at
December 31, 2008, from $6.8 billion at year-end
2007. The increase was driven primarily by
downgrades in the wholesale portfolio.
Industry concentrations for wholesale
criticized exposure as of December 31, 2008
and 2007, were as follows.
2008
2007
December 31,
Credit
% of
Credit
% of
(in millions, except ratios)
exposure
portfolio
exposure
portfolio
Exposure by industry(a)
Real estate
$
7,737
30
%
$
1,070
16
%
Banks and finance companies
2,849
11
498
7
Automotive
1,775
7
1,338
20
Media
1,674
6
303
4
Building materials/construction
1,363
5
345
5
Retail and consumer services
1,311
5
550
8
State and municipal government
847
3
12
—
Asset managers
819
3
212
3
Consumer products
792
3
239
4
Agriculture/paper manufacturing
726
3
138
2
Insurance
712
3
17
—
Chemicals/plastics
591
2
288
4
Healthcare
436
2
246
4
Transportation
319
1
74
1
Metals/mining
262
1
111
2
All other
3,784
15
1,397
20
Total excluding loans
held-for-sale and loans at fair
value
$
25,997
100
%
$
6,838
100
%
Loans held-for-sale and
loans at fair value(b)
2,258
205
Receivables from customers
—
—
Total
$
28,255
$
7,043
(a)
Rankings are based upon exposure at December 31, 2008. The industries presented in
the 2007 table reflect the rankings in the 2008 table.
(b)
Loans held-for-sale and loans at fair value relate primarily
to syndicated loans
and loans transferred from the retained portfolio.
Presented below is a discussion of several
industries to which the Firm has significant
exposure, as well as industries the Firm continues
to monitor because of actual or potential credit
concerns. For additional information, refer to the
tables above and on the preceding page.
•
Real estate: Exposure to this industry grew in 2008 due to the Washington Mutual
transaction, with approximately 70% of this increase consisting of
exposure to multi-family lending. Approximately 45% of the real estate exposure is to large real estate companies and
institutions (e.g. REITS), professional real estate developers, owners, or service
providers, and generally involves real estate leased to third-party tenants. Commercial
construction and development accounted for approximately 13% of the real estate
portfolio at 2008 year-end. Exposure to national and regional single family homebuilders
decreased by 31% from 2007 and represented 5% of the portfolio at 2008 year-end. The increase
in criticized exposure was largely a result of downgrades to select names within the
portfolio, primarily in IB, reflecting the weakening credit environment. The remaining
increase in criticized exposure reflected exposures acquired in the Washington Mutual transaction.
•
Banks and finance companies: Exposure to this industry increased primarily as a
result of higher derivative exposure to commercial banks due to higher volatility and
greater trade volume and to the addition of derivative positions from the Bear Stearns
merger. The percentage of the portfolio that is investment grade has declined slightly
from 2007 as a result of the impact of the weakening credit environment on financial
counterparties. The growth in criticized exposure was primarily a result of downgrades
to specialty finance companies, reflected in loans and lending-related commitments.
•
Automotive: Industry conditions deteriorated significantly in 2008, particularly in
North America, and are expected to remain under pressure in 2009. The largest percentage
of the Firm’s wholesale criticized exposure in this segment is related to Original
Equipment Manufacturers. However, a majority of the year-over-year increase in criticized
exposure related to automotive suppliers which were negatively
affected by
significant declines in automotive production. Most of the Firm’s criticized exposure in
this segment remains performing and is substantially secured.
•
Asset Managers: Exposure in this industry grew from 2007 as a result of increased
derivative exposure to primarily investment grade funds and the
acquisition of loans and lending-related commitments to this industry
due to the Bear Stearns merger.
•
All other: All other in the wholesale credit exposure concentration table on page 85
of this Annual Report at December 31, 2008 included $278.1 billion of credit exposure to 17 industry segments.
Exposures related to SPEs and high-net-worth individuals were 37% and 19%, respectively, of
this
category. SPEs provide secured financing (generally backed by receivables, loans or
bonds on a bankruptcy-remote, nonrecourse or
limited-recourse basis) originated by a diverse
group of companies in industries that are not
highly correlated. For further discussion of
SPEs, see Note 17 on pages 177–186 of this
Annual Report. The remaining all other exposure
is well-diversified across industries and none
comprise more than 2% of total exposure.
In the normal course of business, the Firm uses
derivative instruments to meet the needs of
customers; generate revenue through trading
activities; manage exposure to fluctuations in
interest rates, currencies and other markets; and
manage the Firm’s credit exposure. The notional
amount of the Firm’s derivative contracts
outstanding significantly exceeded, in the Firm’s
view, the possible credit losses that could arise
from such transactions. For most derivative
transactions, the notional amount does not change
hands; it is used simply as a reference to
calculate payments. For further discussion of these
contracts, see Note 32 and Note 34 on pages
202–205 and 210–211 of this Annual Report.
The following tables summarize the aggregate
notional amounts and the net derivative receivables
MTM for the periods presented.
Liquid securities collateral held against
derivative receivables
(19,816
)
(9,824
)
Total, net of all collateral
$
142,810
$
67,312
The amount of derivative receivables reported
on the Consolidated Balance Sheets of $162.6
billion and $77.1 billion at December 31, 2008 and
2007, respectively, is the amount of the
mark-to-market value (“MTM”) or fair value of the
derivative contracts after giving effect to legally
enforceable master netting agreements and cash
collateral held by the Firm. These amounts
represent the cost to the Firm to replace the
contracts at current market rates should the
counterparty default. However, in management’s
view, the appropriate measure of current credit
risk should also reflect additional liquid
securities held as collateral by the Firm of $19.8
billion and $9.8 billion at December 31, 2008 and
2007, respectively, resulting in total exposure,
net of all collateral, of $142.8 billion and $67.3
billion at December 31, 2008 and 2007,
respectively. Derivative receivables, net of
collateral, increased $75.5 billion from December31, 2007, primarily related to the decline in
interest rates, widening credit spreads and
volatile foreign exchange rates reflected in
interest rate, credit and foreign exchange
derivatives, respectively. The increase in 2008
also included positions acquired in the Bear
Stearns merger.
The Firm also holds additional collateral delivered
by clients at the initiation of transactions, and
although this collateral does not reduce the
balances noted in the table above, it is available
as security against potential exposure that could
arise should the MTM of the client’s transactions
move in the Firm’s favor. As of December 31, 2008
and 2007, the Firm held $22.2 billion and $17.4
billion of this additional collateral,
respectively. The derivative receivables MTM also
do not include other credit enhancements in the
form of letters of credit.
While useful as a current view of credit exposure,
the net MTM value of the derivative receivables
does not capture the potential future variability
of that credit exposure. To capture the potential
future variability of credit exposure, the Firm
calculates, on a client-by-client basis, three
measures of potential derivatives-related credit
loss: Peak, Derivative Risk Equivalent (“DRE”), and
Average exposure (“AVG”). These measures all
incorporate netting and collateral benefits, where
applicable.
Peak exposure to a counterparty is a
measure of exposure calculated at a 97.5%
confidence level. Derivative Risk Equivalent
exposure is a measure that expresses the risk of
derivative exposure on a basis intended to be
equivalent to the risk of loan exposures. The
measurement is done by equating the unexpected
loss in a derivative counterparty exposure (which
takes into consideration
both the loss volatility and the credit rating
of the counterparty) with the unexpected loss in a
loan exposure (which takes into consideration only
the credit rating of the counterparty). DRE is a
less extreme measure of potential credit loss than
Peak and is the primary measure used by the Firm
for credit approval of derivative transactions.
Finally, AVG is a measure of the expected MTM value
of the Firm’s derivative receivables at future time
periods, including the benefit of collateral. AVG
exposure over the total life of the derivative
contract is used as the primary metric for pricing
purposes and is used to calculate credit capital
and the Credit Valuation Adjustment (“CVA”), as
further described below. Average exposure was $83.7
billion and
$47.1 billion at December 31, 2008 and 2007,
respectively, compared with derivative
receivables MTM, net of all collateral, of $142.8
billion and $67.3 billion at December 31, 2008
and 2007, respectively.
The MTM value of the Firm’s derivative receivables
incorporates an adjustment, the CVA, to reflect
the credit quality of counterparties. The CVA is
based upon the Firm’s AVG to a counterparty and
the counterparty’s credit spread in the credit
derivatives market. The primary components of
changes in CVA are credit spreads, new deal
activity or unwinds, and changes in the underlying
market environment. The Firm believes that active
risk management is essential to
controlling the dynamic credit risk in the
derivatives portfolio. In addition, the Firm takes
into consideration the potential for correlation
between the Firm’s AVG to a counterparty and the
counterparty’s credit quality within the credit
approval process. The Firm risk manages exposure
to changes in CVA by entering into credit
derivative transactions, as well as interest rate,
foreign exchange, equity and commodity derivative
transactions.
The graph below shows exposure profiles to
derivatives over the next ten years as calculated
by the DRE and AVG metrics. The two measures
generally show declining exposure after the first
year, if no new trades were added to the portfolio.
Exposure profile of derivatives measures
The following table summarizes the ratings profile of the Firm’s derivative receivables MTM,
net of other liquid securities collateral, for the dates indicated.
The increase in noninvestment grade derivative
receivables reflects a weakening credit
environment. The Firm actively pursues the use of
collateral agreements to mitigate counterparty
credit risk in derivatives. The percentage of the
Firm’s derivatives transactions subject to
collateral agreements was 83% as of December 31,2008, largely unchanged from 82% at December31, 2007.
The Firm posted $99.1 billion and $33.5
billion of collateral at December 31, 2008 and
2007, respectively.
Certain derivative and collateral agreements
include provisions that require the counterparty
and/or the Firm, upon specified downgrades in their
respective credit ratings, to post collateral for
the benefit of the other party. The impact of a
single-notch ratings downgrade to JPMorgan Chase
Bank, N.A., from its rating of “AA-” to “A+” at
December 31, 2008, would have required $2.2 billion
of additional collateral to be posted by the Firm.
The impact of a six-notch ratings downgrade (from “AA-” to
“BBB-”) would have required $6.4 billion of additional collateral. Certain derivative contracts also provide for
termination of the contract, generally upon a
downgrade of either the Firm or the counterparty,
at the then-existing MTM value of the derivative
contracts.
Credit derivatives
Credit derivatives are financial contracts that
isolate credit risk from an underlying instrument
(such as a loan or security) and transfer that risk
from one party (the buyer of credit protection) to
another (the seller of credit protection). The Firm
is both a purchaser and seller of credit
protection. As a purchaser of credit protection,
the Firm has risk that the counterparty providing
the credit protection will default. As a seller of
credit protection, the Firm has risk that the
underlying instrument referenced in the contract
will be subject to a credit event. Of the Firm’s $162.6 billion of total derivative receivables MTM
at December 31, 2008, $44.7 billion, or 27%, was
associated with credit derivatives, before the
benefit of liquid securities collateral.
One type of credit
derivatives the Firm enters into with counterparties are credit
defaults swaps (“CDS”). For
further detailed discussion of these and other
types of credit derivatives, see Note 32 on pages
202–205 of this Annual Report. The large majority of CDS are subject to
collateral arrangements to protect the Firm from
counterparty credit risk. In 2008, the frequency
and size of defaults for both trading
counterparties and the underlying debt referenced
in credit derivatives were well above
historical norms. The use of collateral to
settle against defaulting counterparties generally
performed as designed in significantly mitigating
the Firm’s exposure to these counterparties.
During 2008, the Firm worked with other significant
market participants to develop mechanisms to reduce
counterparty credit risk, including the
cancellation of offsetting trades. In 2009, it is
anticipated that one or more central counterparties
for CDS will be established and JPMorgan Chase will
face these central counterparties, or clearing
houses, for an increasing
portion of its CDS business.
The Firm uses
credit derivatives for two primary purposes: first,
in its capacity as a market-maker in the
dealer/client business to meet the needs of
customers; and second, in order to mitigate the
Firm’s own credit risk associated with its overall
derivative receivables and traditional commercial
credit lending exposures (loans and unfunded
commitments), as well as its exposure to
residential and commercial mortgages.
The following table presents the Firm’s notional
amounts of credit derivatives protection purchased
and sold as of December 31, 2008 and 2007,
distinguishing between dealer/client activity and
credit portfolio activity.
Notional amount
Dealer/client
Credit portfolio
December 31,
Protection
Protection
Protection
Protection
(in billions)
purchased(a)
sold(a)
purchased(b)
sold
Total
2008
$
4,097
$
4,198
$
92
$
1
$
8,388
2007
$
3,999
$
3,896
$
70
$
2
$
7,967
(a)
Includes $3.9 trillion at December 31, 2008, of notional exposure within protection purchased and
protection sold where the underlying reference instrument is identical. The remaining
exposure includes single name and index CDS which the Firm purchased to manage the
remaining net protection sold. For a further discussion on credit derivatives, see Note 32
on pages 202–205 of this Annual Report.
(b)
Includes $34.9 billion and $31.1 billion at December 31, 2008 and 2007,
respectively, that represented the notional amount for structured portfolio protection;
the Firm retains a minimal first risk of loss on this portfolio.
Dealer/client business
Within the dealer/client business, the Firm
actively utilizes credit derivatives by buying and
selling credit protection, predominantly on
corporate debt obligations, in response to client
demand for credit risk protection on the underlying
reference instruments. Protection may be bought or
sold by the Firm on single reference debt
instruments (“single-name” credit derivatives),
portfolios of referenced instruments (“portfolio”
credit derivatives) or quoted indices (“indexed”
credit derivatives). The risk positions are largely
matched as the Firm’s exposure to a given reference
entity under a contract to sell protection to a
counterparty may be offset partially, or entirely,
with a contract to purchase protection from another
counterparty on the same underlying instrument. Any
residual default exposure and spread risk is
actively managed by the Firm’s various trading
desks.
At December 31, 2008, the total notional amount of
protection purchased and sold increased $421
billion from year-end 2007. The increase was
primarily as a result of the merger with Bear
Stearns, partially offset by the impact of
industry efforts to reduce offsetting trade
activity.
Credit portfolio activities
In managing its wholesale credit exposure the Firm
purchases protection through single-name and
portfolio credit derivatives to manage the credit
risk associated with loans, lending-related
commitments and derivative receivables. Gains or
losses on the credit derivatives are expected to
offset the unrealized increase or decrease in
credit risk on the loans, lending-related
commitments or derivative receivables. This
activity does not reduce the reported level of
assets on the balance sheet or the level of
reported off-balance sheet commitments, though it
does provide the Firm with credit risk protection.
The Firm also diversifies its exposures by selling
credit protection, which increases exposure to
industries or clients where the Firm has little or
no client-related exposure, however, this activity is not material to
the Firm’s overall credit exposure.
Use of single-name and portfolio credit derivatives
December 31,
Notional amount of protection purchased
(in millions)
2008
2007
Credit derivatives used to manage:
Loans and lending-related commitments
$
81,227
$
63,645
Derivative receivables
10,861
6,462
Total(a)
$
92,088
$
70,107
(a)
Included $34.9 billion and $31.1 billion at December 31, 2008 and 2007,
respectively, that represented the notional amount for structured portfolio protection;
the Firm retains a first risk of loss on this portfolio.
The credit derivatives used by JPMorgan Chase
for credit portfolio management activities do not
qualify for hedge accounting under SFAS 133, and
therefore, effectiveness testing under SFAS 133 is
not performed. Loan interest and fees are generally
recognized in net interest income, and impairment
is recognized in the provision for credit losses.
This asymmetry in accounting treatment between
loans and lending-related commitments and the
credit derivatives utilized in credit portfolio
management activities causes earnings volatility
that is not representative, in the Firm’s view, of
the true changes in value of the Firm’s overall
credit exposure. The MTM related to the Firm’s
credit derivatives used for managing credit
exposure, as well as the MTM related to the CVA,
which reflects the credit quality of derivatives
counterparty exposure, are included in the table
below. These results can vary from period to period
due to market conditions that impact specific
positions in the portfolio. For a further
discussion of credit derivatives, see Note 32 on
pages 202–205 of this Annual Report.
Year ended December 31,
(in millions)
2008
2007
2006
Hedges of lending-related commitments(a)
$
2,216
$
350
$
(246
)
CVA and hedges of CVA(a)
(2,359
)
(363
)
133
Net gains (losses)(b)
$
(143
)
$
(13
)
$
(113
)
(a)
These hedges do not qualify for hedge accounting under SFAS 133.
(b)
Excludes gains of $530 million, $373 million and $56 million for the years ended
December 31, 2008, 2007 and 2006, respectively, of other principal transactions revenue
that are not associated with hedging activities. The amount for 2008 and 2007 incorporates
an adjustment to the valuation of the Firm’s derivative liabilities as a result of the
adoption of SFAS 157 on January 1, 2007.
The Firm also actively manages wholesale credit
exposure through IB and CB loan and commitment
sales. During 2008, 2007 and 2006, these sales of
$3.9 billion, $4.9 billion and $4.0 billion of
loans and commitments, respectively, resulted in
losses of $41 million and $7 million in 2008 and
2007 and gains of $83 million in 2006,
respectively. These results include gains on sales
of nonperforming loans, as discussed on page 83 of
this Annual Report. These activities are not
related to the Firm’s securitization activities,
which are undertaken for liquidity and balance
sheet management purposes. For a further discussion
of securitization activity, see Liquidity Risk
Management
and Note 16 on pages 76–80 and 168–176,
respectively, of this Annual Report.
Lending-related commitments
Wholesale lending-related commitments were
$379.9 billion at December 31, 2008, compared with
$446.7 billion at December 31, 2007. The decrease
was largely related to a reduction in multi-seller
conduit-related commitments. In the Firm’s view,
the total contractual amount of these instruments
is not representative of the Firm’s actual credit
risk exposure or funding requirements. In
determining the amount of credit risk exposure the
Firm has to wholesale lending-related commitments,
which is used as the basis for allocating credit
risk capital to these instruments, the Firm has
established a “loan-equivalent” amount for each
commitment; this amount represents the portion of
the unused commitment or other contingent exposure
that is expected, based upon average portfolio
historical experience, to become outstanding in the
event of a default by an obligor. The
loan-equivalent amount of the Firm’s
lending-related commitments was $204.3 billion and
$238.7 billion as of December 31, 2008 and 2007,
respectively.
Emerging markets country exposure
The Firm has a comprehensive internal process
for measuring and managing exposures to emerging
markets countries. There is no common definition of
emerging markets but the Firm generally, though not
exclusively, includes in its definition those
countries whose sovereign debt ratings are
equivalent to “A+” or lower. Exposures to a country
include all credit-related lending, trading and
investment activities, whether cross-border or
locally funded. In addition to monitoring country
exposures, the Firm uses stress tests to measure
and
manage the risk of extreme loss associated with
sovereign crises.
The following table presents the Firm’s exposure to
the top five emerging markets countries. The
selection of countries is based solely on the
Firm’s largest total exposures by country and not
the Firm’s view of any actual or potentially
adverse credit conditions. Exposure is reported
based upon the country where the assets of the
obligor, counterparty or guarantor are located.
Exposure amounts are adjusted for collateral and
for credit enhancements (e.g., guarantees and
letters of credit) provided by third parties;
outstandings supported by a guarantor outside the
country or backed by collateral held outside the
country are assigned to the country of the
enhancement provider. In addition, the effects of
credit derivative hedges and other short credit or
equity trading positions are reflected in the
following table. Total exposure includes exposure
to both government and private sector entities in a
country.
Lending includes loans and accrued interest receivable, interest-bearing deposits
with banks, acceptances, other monetary assets, issued letters of credit net of
participations, and undrawn commitments to extend credit.
(b)
Trading includes: (1) issuer exposure on cross-border debt and equity instruments,
held both in trading and investment accounts, adjusted for the impact of issuer hedges,
including credit derivatives; and (2) counterparty exposure on derivative and foreign
exchange contracts as well as security financing trades (resale agreements and securities
borrowed).
(c)
Other represents mainly local exposure funded cross-border.
(d)
Local exposure is defined as exposure to a country denominated in local currency,
booked and funded locally. Any exposure not meeting these criteria is defined as
cross-border exposure.
CONSUMER CREDIT PORTFOLIO
JPMorgan Chase’s consumer portfolio consists
primarily of residential mortgages, home equity
loans, credit cards, auto loans, student loans and
business banking loans, with a primary focus on
serving the prime
consumer credit market. The consumer credit
portfolio also includes certain loans acquired in
the Washington Mutual transaction, primarily
mortgage, home equity and credit card loans. The
RFS portfolio includes home equity lines of credit
and mortgage loans with interest-only payment
options to predominantly prime borrowers, as well
as certain payment option loans acquired from
Washington Mutual that may result in negative
amortization.
A substantial portion of the consumer loans
acquired in the Washington Mutual transaction were
identified as credit-impaired in the third quarter
of 2008 based on a preliminary analysis of the
acquired portfolio. In addition, as of the
acquisition date, a $1.4 billion accounting
conformity provision was recorded to reflect the
Firm’s preliminary estimate of incurred losses
related to the portion of the acquired consumer
loans that were not considered to be
credit-impaired. During the fourth quarter of 2008,
the analysis of acquired loans was substantially
completed, resulting in a $12.4
billion increase in the credit-impaired loan balances and a
corresponding decrease in the non-credit-impaired
loan balances. In addition, the estimate of
incurred losses related to the non-credit-impaired
portfolio was finalized, resulting in a $476
million decrease in the accounting conformity
provision for these loans. The purchased
credit-impaired loans, which were identified as
impaired based on an analysis of risk
characteristics, including product type,
loan-to-value ratios, FICO scores and delinquency
status, are accounted for under SOP 03-3 and were
recorded at fair value under SOP 03-3 as of the
acquisition date. The fair value of these loans
includes an estimate of losses that are expected to
be incurred over the estimated remaining lives of
the loans, and therefore no allowance for loan
losses was recorded for these loans as of the
transaction date.
The credit performance of the consumer portfolio
across the entire consumer credit product spectrum
continues to be negatively affected by the economic
environment. High unemployment and weaker overall
economic conditions have resulted in increased
delinquencies, and continued weak housing prices
have driven a significant increase in loss
severity. Nonperforming loans and assets continued
to increase through year-end 2008, a key indicator
that charge-offs will continue to rise in 2009.
Additional deterioration in the overall economic
environment, including continued deterioration in
the labor market, could cause delinquencies to
increase beyond the Firm’s current expectations,
resulting in significant increases in losses in
2009.
Over the past year, the Firm has taken actions to
reduce risk exposure by tightening both
underwriting and loan qualification standards for
real estate lending, as well as for consumer
lending for non-real estate products. Tighter
income verification, more conservative collateral
valuation, reduced loan-to-value maximums and
higher FICO and custom risk score requirements are
just some of the actions taken to date to mitigate
risk. These actions have resulted in significant
reductions in new originations of “risk layered”
loans (e.g., loans with high
loan-to-value ratios to borrowers with low FICO
scores) and improved alignment of loan pricing. New
originations of subprime mortgage loans, option
ARMs and broker originated-mortgage and home equity
loans have been eliminated entirely.
In the fourth quarter of 2008, the Firm announced
plans to significantly expand loss mitigation
efforts related to its mortgage and home equity
portfolios, including a systematic review of the
real estate portfolio to identify homeowners most
in need of assistance. In addition, the Firm
announced plans to open regional counseling
centers, hire additional loan counselors, introduce
new financing alternatives, proactively reach out
to borrowers to offer pre-qualified modifications,
and commence a new process to independently review
each
loan before moving it into the foreclosure
process. During the implementation period of these
loss mitigation efforts, which were substantially
complete in early 2009, the Firm did not place
loans into foreclosure. These loss mitigation
efforts, which generally represent various forms
of term extensions, rate reductions and
forbearances, are
expected
to result in additional increases in the balances of modified loans carried on the Firm’s
balance sheet, including loans accounted for as
troubled debt restructurings, while minimizing the
economic loss to the Firm and assisting homeowners
to remain in their homes.
The following table presents managed consumer credit–related information for the dates indicated.
Total consumer loans – excluding
purchased credit-impaired(d)
394,041
306,298
6,571
2,768
3,112
1,968
9,433
4,466
2.90
1.61
Consumer loans – purchased credit
impaired(d)
Home equity
28,555
NA
NA
NA
—
—
NA
NA
NA
NA
Prime mortgage
21,855
NA
NA
NA
—
—
NA
NA
NA
NA
Subprime mortgage
6,760
NA
NA
NA
—
—
NA
NA
NA
NA
Option ARMs
31,643
NA
NA
NA
—
—
NA
NA
NA
NA
Total purchased credit-impaired
88,813
NA
NA
NA
—
—
NA
NA
NA
NA
Total consumer loans – reported
482,854
306,298
6,571
2,768
3,112
1,968
9,433
4,466
2.71
1.61
Credit card – securitized(e)
85,571
72,701
—
—
1,802
1,050
3,612
2,380
4.53
3.43
Total consumer loans – managed
568,425
378,999
6,571
2,768
4,914
3,018
13,045
6,846
3.06
1.97
Consumer lending-related commitments:
Home
equity(f)
95,743
74,191
Prime mortgage
5,079
7,394
Subprime mortgage
—
16
Option ARMs
—
—
Auto loans
4,726
8,058
Credit
card(f)
623,702
714,848
All other loans
12,257
11,429
Total lending-related commitments
741,507
815,936
Total consumer credit portfolio
$
1,309,932
$
1,194,935
Memo: Credit card – managed
$
190,317
$
157,053
$
4
$
7
$
4,451
$
2,597
$
8,168
$
5,496
5.01
%
3.68
%
(a)
Includes RFS, CS and residential mortgage loans reported in the Corporate/Private
Equity segment, as well as approximately $80.0 billion in non-credit-impaired consumer
loans acquired in the Washington Mutual transaction.
(b)
Excludes operating lease-related assets of $2.2 billion and $1.9 billion for
December 31, 2008 and 2007, respectively.
(c)
Includes loans for prime mortgage and other (largely student loans) of $206
million and $1.8 billion at December 31, 2008, respectively, and $570 million and $3.4
billion at December 31, 2007, respectively.
(d)
Purchased credit-impaired loans represent loans acquired in the Washington Mutual
transaction that were considered credit-impaired under SOP 03-3, and include $6.4 billion
of loans that were considered nonperforming by Washington Mutual prior to the transaction
closing. Under SOP 03-3, these loans are considered to be performing loans as of the
transaction date and accrete interest income over the estimated life of the loan when
cash flows are reasonably estimable, even if the underlying loans are contractually past
due. For additional information, see Note 14 on pages 163–166 of this Annual Report.
(e)
Represents securitized credit card receivables. For a further discussion of credit
card securitizations, see CS on pages 51–53 of this Annual Report.
(f)
The credit card and home equity lending-related commitments represent the total
available lines of credit for these products. The Firm has not experienced, and does not
anticipate, that all available lines of credit will be utilized at the same time. For
credit card commitments and home equity commitments (if certain conditions are met), the
Firm can reduce or cancel these lines of credit by providing the borrower prior notice or,
in some cases, without notice as permitted by law.
(g)
Excludes purchased credit-impaired loans accounted for under SOP 03-3 that were
acquired as part of the Washington Mutual transaction. These loans are accounted for on a
pool basis and the pools are considered to be performing under SOP 03-3.
(h)
Excludes nonperforming assets related to: (1) loans eligible for repurchase, as
well as loans repurchased from Governmental National Mortgage Association (“GNMA”) pools that are insured by U.S. government agencies of
$3.3 billion for December 31, 2008 and $1.5 billion for December 31, 2007; and (2) student
loans that are 90 days past due and still accruing, which are insured by U.S. government
agencies under the Federal Family Education Loan Program of $437 million and $417 million
as of December 31, 2008 and 2007, respectively. These amounts for GNMA and student loans
are excluded, as reimbursement is proceeding normally.
(i)
During the second quarter of 2008, the Firm’s policy for classifying subprime
mortgage and home equity loans as nonperforming was changed to conform to all the other
home lending products. Amounts for 2007 have been revised to reflect
this change.
(j)
Net charge-off rates exclude average loans held-for-sale of $2.8 billion and $10.6
billion for 2008 and 2007, respectively.
The following table presents the consumer nonperforming assets by business segment as of
December 31, 2008 and 2007.
2008
2007
Assets acquired
Assets acquired in
loan satisfactions
loan satisfactions
As of December 31,
Nonperforming
Real estate
Nonperforming
Nonperforming
Real estate
Nonperforming
(in millions)
loans
owned
Other
assets
loans
owned
Other
assets
Retail Financial
Services
$
6,548
$
2,183
$
110
$
8,841
$
2,760
$
477
$
72
$
3,309
Card Services
4
—
—
4
7
—
—
7
Corporate/Private
Equity
19
1
—
20
1
—
—
1
Total
$
6,571
$
2,184
$
110
$
8,865
$
2,768
$
477
$
72
$
3,317
The Firm regularly evaluates market conditions
and overall economic returns and makes an initial
determination of whether new originations will be
held-for-investment or sold within the foreseeable
future. The Firm also periodically evaluates the
expected economic returns of previously originated
loans under prevailing market conditions to
determine whether their designation as
held-for-sale or held-for-investment continues to
be appropriate. When the Firm determines that a
change in this designation is appropriate, the
loans are transferred to the appropriate
classification. During the third and fourth
quarters of 2007, in response to changes in market
conditions, the Firm designated as
held-for-investment all new originations of
subprime mortgage loans, as well as subprime
mortgage loans that were previously designated
held-for-sale. In addition, all new prime mortgage
originations that cannot be sold to U.S. government
agencies and U.S. government-sponsored enterprises
have been designated as held-for-investment. Prime
mortgage loans originated with the intent to sell
are accounted for at fair value under SFAS 159 and
are classified as trading assets in the
Consolidated Balance Sheets.
The following discussion relates to the specific
loan and lending-related categories within the
consumer portfolio. Information regarding combined loan-to-value ratios
(“CLTVs”) and loan-to-value ratios (“LTVs”) were
estimated based on the initial appraisal obtained at the time of
origination, adjusted using relevant market indices for housing price
changes that have occurred since origination. The estimated value of
the homes could vary from actual market values due to changes in
condition of the underlying property, variations in housing price
changes within metropolitan statistical areas (“MSAs”) and
other factors.
Home equity: Home equity loans at December 31,2008, were $114.3 billion, excluding purchased
credit-impaired loans, an increase of $19.5 billion
from year-end 2007, primarily reflecting the
addition of loans acquired in the Washington Mutual
transaction. The 2008 provision for credit losses
for the home equity portfolio includes net
increases of $2.2 billion to the allowance for loan
losses for 2008 for the heritage JPMorgan Chase
portfolio as a result of the economic environment
noted above. The Firm estimates that loans with effective CLTVs in excess of 100%
represented approximately 22% of the home equity portfolio. In
response to continued economic weakness, loan
underwriting and account management criteria have
been tightened, with a particular focus on
metropolitan
statistical areas (“MSAs”) with the most
significant housing price declines. New
originations of home equity loans have decreased
significantly, as additional loss mitigation
strategies have been employed; these strategies
include the elimination of stated income and broker
originated loans, a significant reduction of
maximum CLTVs for
new originations, which now range from 50% to 70%,
and additional restrictions on new originations in
geographic
areas experiencing the greatest housing
price depreciation and highest unemployment. Other
loss mitigation strategies include the reduction or
closure of outstanding credit lines for borrowers
who have experienced significant increases in CLTVs
or decreases in creditworthiness (e.g. declines in
FICO scores.)
Mortgage: Mortgage loans at December 31, 2008,
which include prime mortgages, subprime mortgages,
option ARMs and loans held-for-sale, were $96.8
billion, excluding purchased credit-impaired loans,
reflecting a $40.8 billion increase from year-end
2007, primarily reflecting the addition of loans
acquired in the Washington Mutual transaction.
Prime mortgages of $72.5 billion increased $31.9
billion from December 2007 as a result of loans
acquired in the Washington Mutual transaction and,
to a lesser extent, additional originations into
the portfolio. The 2008 provision for credit losses
includes a net increase of $1.1 billion to the
allowance for loan losses for the heritage JPMorgan
Chase portfolio as a result of the economic
environment noted above. The Firm estimates that loans with effective
LTVs in excess of 100%
represented approximately 18% of the prime mortgage portfolio.
The Firm has tightened underwriting standards for
nonconforming prime mortgages in recent quarters,
including eliminating stated income products,
reducing LTV maximums, and eliminating the broker
origination channel.
Subprime mortgages of $15.3 billion, excluding
purchased credit-impaired loans, decreased slightly
from December 31, 2007, as the discontinuation of
new originations was predominantly offset by loans
acquired in the Washington Mutual transaction. The
year-to-date provision for credit losses includes a
net increase of $1.4 billion to the allowance for
loan losses for the heritage JPMorgan Chase
portfolio as a result of the economic environment
noted above. The Firm estimates that loans with effective
LTVs in excess of 100% represented approximately 27%
of the subprime mortgage portfolio.
Option ARMs of $9.0 billion, excluding purchased
credit-impaired loans, were acquired in the
Washington Mutual transaction. New originations
of option ARMs were discontinued by Washington
Mutual prior to the date of the Washington
Mutual transaction. This portfolio is primarily
comprised of loans
with low LTVs and high borrower FICOs and for which
the Firm currently expects substantially lower
losses in comparison with the purchased
credit-impaired portfolio. The Firm has not, and
does not, originate option ARMs.
Option ARMs are adjustable-rate mortgage products
that provide the borrower with the option to make a
fully amortizing, interest-only, or minimum
payment. The minimum payment is based upon the
interest rate charged during the introductory
period. This introductory rate is typically well
below the fully indexed rate. The fully indexed
rate is calculated using an index rate plus a
margin. Once the introductory period ends, the
contractual interest rate charged on the loan
increases to the fully indexed rate. If the
borrower continues to make the minimum monthly
payment after the introductory period ends, the
payment may not be sufficient to cover interest
accrued in the previous month. In this case, the
loan will “negatively amortize” as unpaid interest
is deferred and added to the principal balance of
the loan. Option ARMs typically become fully
amortizing loans upon reaching a negative
amortization cap or on dates specified in the
borrowing agreement, at which time the required
monthly payment generally increases substantially.
Auto loans: As of December 31, 2008, auto loans of
$42.6 billion increased slightly from year-end
2007. The allowance for loan losses for the auto
loan portfolio was increased during 2008,
reflecting an increase in estimated losses due to
an increase in loss severity and further
deterioration of older vintage loans as a result of
the worsening credit environment and declines in
auto resale values. The auto loan portfolio
reflects a high concentration of prime quality
credits. In response to recent increases in loan
delinquencies and credit losses, particularly in
MSAs experiencing the greatest housing price
depreciation and highest unemployment, credit
underwriting criteria have been tightened, which
has resulted in the reduction of both extended-term
and high loan-to-value financing.
Credit card: JPMorgan Chase analyzes its credit
card portfolio on a managed basis, which includes
credit card receivables on the Consolidated Balance
Sheets and those receivables sold to investors
through securitization. Managed credit card
receivables were $190.3 billion at December 31,2008, an increase of $33.3 billion from year-end
2007, reflecting the acquisition of credit card
loans as part of the Washington Mutual transaction,
as well as organic growth in the portfolio.
The managed credit card net charge-off rate
increased to 5.01% for 2008 from 3.68% in 2007.
This increase was due primarily to higher
charge-offs as a result of the current economic
environment, especially in areas experiencing the
greatest housing price depreciation and highest
unemployment. The 30-day managed delinquency rate
increased to 4.97% at December 31, 2008, from 3.48%
at December 31, 2007, partially as a result of the
addition of credit
card loans acquired in the Washington Mutual
transaction. Excluding the Washington Mutual
portfolio, the 30-day managed delinquency rate was
4.36%. The Allowance for loan losses was increased
due to higher estimated net charge-offs in the
portfolio. As a result of continued weakness in
housing markets, account acquisition credit
criteria and account management credit practices
have been tightened, particularly in MSAs
experiencing significant home price declines. The
managed credit card portfolio continues to reflect
a well-seasoned, largely rewards-based portfolio
that has good U.S. geographic diversification.
All other loans: All other loans primarily include
business banking loans (which are highly
collateralized loans, often with personal loan
guarantees), student loans, and other secured and
unsecured consumer loans. As of December 31, 2008,
other loans, including loans held-for-sale, of
$35.5 billion were up $6.8 billion from year-end
2007, primarily as a result of organic growth in
business banking loans and student loans, as well
as an increase in business banking loans as a
result of the Washington Mutual transaction.
Purchased credit-impaired loans: Purchased
credit-impaired loans of $88.8 billion in the home
lending portfolio represent loans acquired in the
Washington Mutual transaction that were recorded at
fair value at the time of acquisition under SOP
03-3. The fair value of these loans includes an
estimate of losses that are expected to be incurred
over the estimated remaining lives of the loans,
and therefore no allowance for loan losses was
recorded for these loans as of the transaction
date. Through year-end 2008, the credit performance
of these loans has generally been consistent with
the assumptions used in determining the initial
fair value of these loans, and the Firm’s original
expectations regarding the amounts and timing of
future cash flows has not changed. A probable
decrease in management’s expectation of future cash
collections related to these loans could result in
the need to record an allowance for credit losses
related to these loans in the future. A significant
and probable increase in expected cash flows would
generally result in an increase in interest income
recognized over the remaining life of the
underlying pool of loans.
Other real estate owned: As part of the residential
real estate foreclosure process, loans are written
down to net realizable value less a cost to sell
the asset. In those instances where the Firm gains
title, ownership and possession of individual
properties at the completion of the foreclosure
process, these Other Real Estate Owned (OREO)
assets are managed for prompt sale and disposition
at the best possible economic value. Any further
gain or loss on sale of the disposition of OREO
assets are recorded as part of other income.
The following tables present the geographic distribution of consumer credit outstandings by product
as of December 31, 2008 and 2007, excluding purchased credit-impaired loans.
Excluding the purchased credit-impaired loans acquired in the Washington Mutual
transaction.
ALLOWANCE FOR CREDIT LOSSES
JPMorgan Chase’s allowance for credit losses is
intended to cover probable credit losses, including
losses where the asset is not specifically
identified or the size of the loss has not been
fully determined. At least quarterly, the allowance
for credit losses is reviewed by the Chief
Executive Officer, the Chief Risk Officer, the
Chief Financial Officer and the Controller of the
Firm, and discussed with the Risk Policy and Audit
Committees of the Board of Directors of the Firm.
The allowance is reviewed relative to the risk
profile of the Firm’s credit portfolio and current
economic conditions and is adjusted if, in
management’s judgment, changes are warranted. The
allowance includes an asset-specific and a
formula-based component. For further discussion of
the components of the allowance for credit losses,
see Critical accounting estimates used by the Firm
on pages 107–111 and Note 15 on pages 166–168 of
this Annual Report. At December 31, 2008,
management deemed the allowance for credit losses
to be appropriate (i.e., sufficient to absorb
losses that are inherent in the portfolio,
including losses that are not specifically
identified or for which the size of the loss has
not yet been fully determined).
Cumulative effect of change in
accounting principles(a)
—
—
—
(56
)
—
(56
)
Beginning balance at January 1, adjusted
3,154
6,080
9,234
2,655
4,568
7,223
Gross charge-offs
521
10,243
10,764
185
5,182
5,367
Gross recoveries
(119
)
(810
)
(929
)
(113
)
(716
)
(829
)
Net charge-offs
402
9,433
9,835
72
4,466
4,538
Provision for loan losses:
Provision excluding accounting conformity
2,895
16,765
19,660
598
5,940
6,538
Accounting conformity(b)
641
936
1,577
—
—
—
Total provision for loan losses
3,536
17,701
21,237
598
5,940
6,538
Acquired allowance resulting from
Washington Mutual
transaction
229
2,306
2,535
—
—
—
Other
28
(c)
(35
)(c)
(7
)
(27
)(i)
38
(i)
11
Ending balance at December 31
$
6,545
$
16,619
$
23,164
$
3,154
$
6,080
$
9,234
Components:
Asset-specific
$
712
$
74
$
786
$
108
$
80
$
188
Formula-based
5,833
16,545
22,378
3,046
6,000
9,046
Total allowance for loan losses
$
6,545
$
16,619
$
23,164
$
3,154
$
6,080
$
9,234
Lending-related commitments:
Beginning balance at January 1,
$
835
$
15
$
850
$
499
$
25
$
524
Provision for lending-related commitments
Provision excluding accounting conformity
(214
)
(1
)
(215
)
336
(10
)
326
Accounting conformity(b)
5
(48
)
(43
)
—
—
—
Total provision for lending-related
commitments
(209
)
(49
)
(258
)
336
(10
)
326
Acquired allowance resulting from
Washington Mutual
transaction
—
66
66
—
—
—
Other
8
(c)
(7)
(c)
1
—
—
—
Ending balance at December 31
$
634
$
25
$
659
$
835
$
15
$
850
Components:
Asset-specific
$
29
$
—
$
29
$
28
$
—
$
28
Formula-based
605
25
630
807
15
822
Total allowance for
lending-related commitments
$
634
$
25
$
659
$
835
$
15
$
850
Total allowance for credit losses
$
7,179
$
16,644
$
23,823
$
3,989
$
6,095
$
10,084
Allowance for loan losses to loans
2.64
%(d)
3.46
%(e)(h)
3.18
%(d)(e)(h)
1.67
%(d)
2.01
%(e)
1.88
%(d)(e)
Allowance for loan losses to loans
excluding
purchased credit-impaired loans
2.64
(d)
4.24
(e)
3.62
(d)(e)
1.67
(d)
2.01
(e)
1.88
(d)(e)
Net charge-off rates
0.18
(f)
2.71
(g)(h)
1.73
(f)(g)(h)
0.04
(f)
1.61
(g)
1.00
(f)(g)
Net charge-off rates excluding purchased
credit-impaired loans
0.18
(f)
2.90
(g)
1.81
(f)(g)
0.04
(f)
1.61
(g)
1.00
(f)(g)
(a)
Reflects the effect of the adoption of SFAS 159 at January 1, 2007. For a further
discussion of SFAS 159, see Note 5 on pages 144–146 of this Annual Report.
(b)
Related to the Washington Mutual transaction in 2008.
(c)
Primarily related to the transfer of loans and lending-related commitments from RFS to CB during the first quarter
of 2008.
(d)
Wholesale loans held-for-sale and loans at fair value were $14.0 billion and $23.6
billion at December 31, 2008 and 2007, respectively. These amounts were excluded when
calculating the allowance coverage ratios.
(e)
Consumer loans held-for-sale were $2.0 billion and $4.0 billion at December 31,2008 and 2007, respectively. These amounts were excluded when calculating the allowance
coverage ratios.
(f)
Average wholesale loans held-for-sale and loans at fair value were $18.9 billion
and $18.6 billion for the years ended December 31, 2008 and 2007, respectively. These
amounts were excluded when calculating the net charge-off rates.
(g)
Average consumer (excluding card) loans held-for-sale and loans at fair value were
$2.8 billion and $10.6 billion for the years ended December 31, 2008 and 2007,
respectively. These amounts were excluded when calculating the net charge-off rates.
(h)
Includes $88.8 billion of home lending credit-impaired loans acquired in the
Washington Mutual transaction and accounted for under SOP 03-3 at December 31, 2008. These
loans were accounted for at fair value on the acquisition date, which reflected expected
cash flows (including credit losses) over the remaining life of the portfolio. No
allowance for loan losses has been recorded for these loans as of December 31, 2008.
(i)
Partially related to the transfer of allowance between wholesale and consumer in
conjunction with prime mortgages transferred to the Corporate/Private Equity sector.
The allowance for credit losses increased $13.7
billion from the prior year to $23.8 billion. The increase
included $4.1 billion of allowance related to noncredit impaired
loans acquired in the Washington Mutual transaction and the related
accounting conformity provision. Excluding held-for-sale loans, loans
carried at fair value, and purchased
credit-impaired consumer loans, the allowance for
loan losses represented
3.62% of loans at December 31, 2008, compared
with 1.88% at December 31, 2007.
The consumer allowance for loan losses increased
$10.5 billion from the prior year as a result of
the Washington Mutual transaction and increased
allowance for loan loss in residential real estate
and credit card. The increase included additions to
the allowance for loan losses of $4.7 billion
driven by higher estimated losses for residential
mortgage and home equity loans as the weak labor
market and weak overall economic conditions have
resulted in increased delinquencies, while
continued weak housing prices have driven a
significant increase in loss severity. The
allowance for loan losses related to credit card
increased $4.3 billion from the prior year
primarily due to the acquired allowance and
subsequent conforming provision for loan loss
related to the Washington Mutual Bank acquisition
and an increase in provision for loan losses of
$2.3 billion in 2008 over
2007, as higher estimated net-charge offs are
expected in the portfolio resulting from the
current economic conditions.
The wholesale allowance for loan losses increase of
$3.4 billion from December 31, 2007, reflected the
effect of a weakening credit environment and the
transfer of $4.9 billion of funded and unfunded
leveraged lending commitments to retained loans
from held-for-sale.
To provide for
the risk of loss inherent in the Firm’s process of
extending credit, an allowance for lending-related
commitments is held for both wholesale and
consumer, which is reported in other liabilities.
The wholesale component is computed using a
methodology similar to that used for the wholesale
loan portfolio, modified for expected maturities
and probabilities of drawdown and has an
asset-specific component and a formula-based
component. For a further discussion on the
allowance for lending-related commitment see Note 15 on page 166–168 of this Annual Report. The allowance for lending-related commitments for
both wholesale and consumer was $659 million and $850
million at December 31, 2008 and 2007,
respectively. The decrease reflects the reduction
in lending-related commitments at December 31, 2008. For more information see page 90 of this Annual Report.
The following table presents the allowance for loan losses and net charge-offs (recoveries) by
business segment at December 31, 2008 and 2007.
The managed provision for credit losses includes amounts related to credit card
securitizations. For the year ended December 31, 2008, the increase in the provision for credit
losses was due to year-over-year increase in the allowance for
credit losses largely related to the home equity, subprime mortgage, prime mortgage and credit card loan portfolios in the consumer
businesses as well as in the allowance for credit losses related to
the wholesale portfolio. The increase in the wholesale provision for loan
losses from the prior year was due to the weakening credit environment, loan growth and the
transfer of $4.9 billion of funded and unfunded leverage lending commitments to retained loans from
held-for-sale. The decrease in provision for lending-related commitments from the prior year
benefited from reduced balances of lending-related commitments.
Provision for
Year ended December 31,
Provision for loan losses
lending-related commitments
Total provision for credit losses
(in millions)
2008
2007
2006
2008
2007
2006
2008
2007
2006
Investment Bank
$
2,216
$
376
$
112
$
(201
)
$
278
$
79
$
2,015
$
654
$
191
Commercial Banking
505
230
133
(41
)
49
27
464
279
160
Treasury & Securities
Services
52
11
(1
)
30
8
—
82
19
(1
)
Asset Management
87
(19
)
(30
)
(2
)
1
2
85
(18
)
(28
)
Corporate/Private
Equity(a)(b)
676
—
(1
)
5
—
—
681
—
(1
)
Total Wholesale
3,536
598
213
(209
)
336
108
3,327
934
321
Retail Financial Services
9,906
2,620
552
(1
)
(10
)
9
9,905
2,610
561
Card Services – reported
6,456
3,331
2,388
—
—
—
6,456
3,331
2,388
Corporate/Private
Equity(a)(c)(d)
1,339
(11
)
—
(48
)
—
—
1,291
(11
)
—
Total Consumer
17,701
5,940
2,940
(49
)
(10
)
9
17,652
5,930
2,949
Total provision for credit losses – reported
21,237
6,538
3,153
(258
)
326
117
20,979
6,864
3,270
Credit card – securitized
3,612
2,380
2,210
—
—
—
3,612
2,380
2,210
Total provision for credit losses – managed
$
24,849
$
8,918
$
5,363
$
(258
)
$
326
$
117
$
24,591
$
9,244
$
5,480
(a)
Includes accounting conformity provisions related to the Washington Mutual
transaction in 2008.
(b)
Includes provision expense related to loans acquired in the Bear Stearns merger in
the second quarter of 2008.
(c)
Includes amounts related to held-for-investment prime mortgages transferred from
AM to the Corporate/Private Equity segment.
(d)
In November 2008, the Firm transferred $5.8 billion of higher quality credit card
loans from the legacy Chase portfolio to a securitization trust previously established by
Washington Mutual (“the Trust”). As a result of converting higher credit quality
Chase-originated on-book receivables to the Trust’s seller’s interest which has a higher
overall loss rate reflective of the total assets within the Trust, approximately $400
million of incremental provision expense was recorded during the fourth quarter. This
incremental provision expense was recorded in the Corporate segment as the action related
to the acquisition of Washington Mutual’s banking operations. For further discussion of
credit card securitizations, see Note 16 on pages 169–170 of this Annual Report.
MARKET RISK MANAGEMENT
Market risk is the exposure to an adverse
change in the market value of portfolios and
financial instruments caused by a change in market
prices or rates.
Market risk management
Market risk is identified, measured, monitored, and
controlled by Market Risk, a corporate risk
governance function independent of the lines of
business. Market Risk seeks to facilitate efficient
risk/return decisions, reduce volatility in
operating performance and make the Firm’s market
risk profile transparent to senior management, the
Board of Directors and regulators. Market Risk is
overseen by the Chief Risk Officer and performs the
following functions:
•
Establishment of a comprehensive market risk policy framework
•
Independent measurement, monitoring and control of business segment market risk
•
Definition, approval and monitoring of limits
•
Performance of stress testing and qualitative risk assessments
Risk identification and classification
Market Risk works in partnership with the
business segments to identify market risks
throughout the Firm and define and monitor
market risk policies and procedures. All
business segments are
responsible for the comprehensive identification
and verification of market risks within their
units. Risk-taking businesses have functions that
act independently from trading personnel and are
responsible for verifying risk exposures that the
business takes. In addition to providing
independent oversight for market risk arising from
the business segments, Market Risk is also
responsible for identifying exposures which may not
be large within individual business segments but
which may be large for the Firm in the aggregate.
Regular meetings are held between Market Risk and
the heads of risk-taking businesses to discuss and
decide on risk exposures in the context of the
market environment and client flows.
Positions that expose the Firm to market risk can
be classified into two categories: trading and
nontrading risk. Trading risk includes positions
that are held by the Firm as part of a business
segment or unit, the main business strategy of
which is to trade or make markets. Unrealized gains and losses in these positions are
generally reported in principal transactions
revenue. Nontrading risk includes securities and
other assets held for longer-term investment,
mortgage servicing rights, and securities and
derivatives used to manage the Firm’s
asset/liability exposures. Unrealized gains and
losses in these positions are generally not
reported in principal transactions revenue.
The Firm makes markets and trades its products
across several different asset classes. These asset
classes include primarily fixed income (which
includes interest rate risk and credit spread
risk), foreign exchange, equities and commodities.
Trading risk arises from positions in these asset
classes and may lead to the potential decline in
net income (i.e., economic sensitivity)
due to adverse changes in market rates, whether
arising from client activities or proprietary
positions taken by the Firm.
Nontrading risk
Nontrading risk arises from execution of the Firm’s
core business strategies, the delivery of products
and services to its customers, and the positions
the Firm undertakes to risk-manage its exposures.
These exposures can result from a variety of
factors, including differences in the timing among
the maturity or repricing of assets, liabilities
and off-balance sheet instruments. Changes in the
level and shape of market interest rate curves also
may create interest rate risk, since the repricing
characteristics of the Firm’s assets do not
necessarily match those of its liabilities. The
Firm is also exposed to basis risk, which is the
difference in the repricing characteristics of two
floating-rate indices, such as the prime rate and
3-month LIBOR. In addition, some of the Firm’s
products have embedded optionality that impact
pricing and balances.
The Firm’s mortgage banking activities give rise to
complex interest rate risks, as well as option and
basis risk. Option risk arises primarily from
prepayment options embedded in mortgages and
changes in the probability of newly originated
mortgage commitments actually closing. Basis risk
results from different relative movements between
mortgage rates and other interest rates.
Risk measurement
Tools used to measure risk
Because no single measure can reflect all aspects
of market risk, the Firm uses various metrics, both
statistical and nonstatistical, including:
•
Nonstatistical risk measures
•
Value-at-risk (“VaR”)
•
Loss advisories
•
Drawdowns
•
Economic value stress testing
•
Earnings-at-risk stress testing
•
Risk identification for large exposures (“RIFLE”)
Nonstatistical risk measures
Nonstatistical risk measures other than stress
testing include net open positions, basis point
values, option sensitivities, market values,
position concentrations and position turnover.
These measures provide granular information on the
Firm’s market risk exposure. They are aggregated by
line of business and by risk type, and are used for
monitoring limits, one-off approvals and tactical
control.
Value-at-risk (“VaR”)
JPMorgan Chase’s primary statistical risk measure,
VaR, estimates the potential loss from adverse
market moves in an ordinary market environment and
provides a consistent cross-business measure of
risk profiles and levels of diversification. VaR is
used for comparing risks across businesses,
monitoring limits, and as an input to economic
capital calculations. VaR provides risk
transparency in a normal trading environment. Each
business day the Firm undertakes a comprehensive
VaR calculation that includes both its trading and
its nontrading risks. VaR for nontrading risk
measures the amount of potential change in the fair
values of the exposures related to these risks;
however, for such risks, VaR is not a measure of
reported revenue since nontrading activities are
generally not marked to market through net income.
Hedges of nontrading activities may be included in
trading VaR since they are marked to market.
To calculate VaR, the Firm uses historical
simulation, based on a one-day time horizon and an
expected tail-loss methodology, which measures risk
across instruments and portfolios in a consistent
and comparable way. The simulation is based upon
data for the previous 12 months. This approach
assumes that historical changes in market values
are representative of future changes; this is an
assumption that may not always be accurate,
particularly given the volatility in the current
market environment. For certain products, an actual
price time series is not available. In such cases,
the historical simulation is done using a proxy
time series to estimate the risk. It is likely that
using an actual price time series for these
products, if available, would impact the VaR
results presented. In addition, certain risk
parameters, such as correlation risk among certain
IB trading instruments, are not fully captured in
VaR.
In the third quarter of 2008, the Firm revised its
VaR measurement to include additional risk
positions previously excluded from VaR, thus
creating, in the Firm’s view, a more comprehensive
view of its market risks. In addition, the Firm
moved to calculating VaR using a 95% confidence
level to provide a more stable measure of the VaR
for day-to-day risk management. The following sections describe JPMorgan Chase’s
VaR measures under both the legacy 99% confidence
level as well as the new 95% confidence level. The
Firm intends to solely present the VaR at the 95%
confidence level once information for two complete
year-to-date periods is available.
IB trading VaR by risk type and credit portfolio VaR
As of or for the year ended
2008
2007
At December 31,
December 31,(a) (in millions)
Average
Minimum
Maximum
Average
Minimum
Maximum
2008
2007
By risk type:
Fixed income
$
181
$
99
$
409
$
80
$
25
$
135
$
253
$
106
Foreign exchange
34
13
90
23
9
44
70
22
Equities
57
19
187
48
22
133
69
27
Commodities and other
32
24
53
33
21
66
26
27
Diversification
(108
)(b)
NM
(c)
NM
(c)
(77
)(b)
NM
(c)
NM
(c)
(152
)(b)
(82
)(b)
Trading VaR
$
196
$
96
$
420
$
107
$
50
$
188
$
266
$
100
Credit portfolio VaR
69
20
218
17
8
31
171
22
Diversification
(63
)(b)
NM
(c)
NM
(b)
(18
)(b)
NM
(c)
NM
(c)
(120
)(b)
(19
)(b)
Total trading and credit
portfolio VaR
$
202
$
96
$
449
$
106
$
50
$
178
$
317
$
103
(a)
The results for the year ended December 31, 2008, include five months of heritage
JPMorgan Chase only results and seven months of results for the combined JPMorgan Chase
and Bear Stearns; 2007 reflects heritage JPMorgan Chase results only.
(b)
Average and period-end VaRs were less than the sum of the VaRs of its market risk
components, which is due to risk offsets resulting from portfolio diversification. The
diversification effect reflects the fact that the risks were not perfectly correlated. The
risk of a portfolio of positions is therefore usually less than the sum of the risks of
the positions themselves.
(c)
Designated as not meaningful (“NM”) because the minimum and maximum may occur on
different days for different risk components, and hence it is not meaningful to compute a
portfolio diversification effect.
Trading VaR includes substantially all trading
activities in IB. Beginning in the fourth quarter
of 2008, the credit spread sensitivities of certain
mortgage products were included in trading VaR.
This change had an insignificant net impact on the
average fourth quarter 2008 VaR. However, trading
VaR does not include: held-for-sale funded loan and
unfunded commitments positions (however, it does
include hedges of those positions); the debit
valuation adjustments (“DVA”) taken on derivative
and structured liabilities to reflect the credit
quality of the Firm; the MSR portfolio; and
securities and instruments held by corporate
functions, such as Corporate/Private Equity. See
the DVA Sensitivity table on page 103 of this
Annual Report for further details. For a discussion
of MSRs and the corporate functions, see Note 4 on
pages 129–143, Note 18 on pages 186–189 and
Corporate/ Private Equity on pages 61–63 of this
Annual Report.
2008
VaR results
IB’s average total trading and credit portfolio VaR
was $202 million for 2008, compared with $106
million for 2007, and includes the positions from
the Bear Stearns merger since May 31, 2008. The
increase in average
and maximum VaR during 2008 compared with the prior
year was primarily due to increased volatility
across virtually all asset classes. In addition,
increased hedges of positions not specifically
captured in VaR – for example, macro hedge
strategies that have been deployed to mitigate the
consequences of a systemic risk event and hedges of
loans held-for-sale – significantly increased the
VaR compared with the prior period.
For 2008, compared with the prior year, average
trading VaR diversification increased to $108
million from $77 million, reflecting the impact of
the Bear Stearns merger. In general, over the
course of the year, VaR exposures can vary
significantly as positions change, market
volatility fluctuates and diversification benefits
change.
VaR
backtesting
To evaluate the soundness of its VaR model, the
Firm conducts daily back-testing of VaR against
daily IB market risk-related revenue, which is
defined as the change in value of principal
transactions revenue (less Private Equity
gains/losses) plus any trading-related net interest
income, brokerage commissions, underwriting fees or
other revenue. The daily IB market risk-related
revenue excludes gains and losses on held-for-sale
funded loans and unfunded commitments and from DVA.
The following histogram illustrates the daily
market risk-related gains and losses for IB trading
businesses for the year ended 2008. The chart shows
that IB posted market risk-related gains on 165 of
the 262 days in this period, with 54 days exceeding
$120 million. The inset graph looks at those days
on which IB experienced losses and depicts the
amount by which 99% confidence level VaR exceeded
the actual loss on each of those days. During the
year ended December 31, 2008, losses were sustained
on 97 days; losses exceeded the VaR measure on
three of those days compared with eight days for
the year ended 2007. The Firm would expect to incur
losses greater than those predicted by the 99%
confidence level VaR estimates once in every 100
trading days, or about two to three times a year.
Diversification benefit to IB trading and credit portfolio VaR
(36
)
(57
)
Total IB trading and credit portfolio VaR
$
176
$
194
Consumer
Lending VaR
37
112
Corporate Risk Management VaR
48
114
Diversification benefit to total other VaR
(19
)
(48
)
Total other VaR
$
66
$
178
Diversification benefit to total IB and other VaR
(40
)
(86
)
Total IB and other VaR
$
202
$
286
The Firm’s new 95% VaR measure includes all
the risk positions taken into account under the
99% confidence level VaR measure, as well as
syndicated lending facilities the Firm intends to
distribute (and, beginning in the fourth quarter
of 2008, the credit spread sensitivities of
certain mortgage products). The Firm utilizes
proxies
to estimate the VaR for these mortgage and credit
products since daily time series are largely not
available. In addition, the new VaR measure
includes certain actively managed positions
utilized as part of the Firm’s risk management
function within Corporate and in the Consumer
Lending businesses to provide a total IB and other
VaR
measure. In the Firm’s view, including these
items in VaR produces a more complete perspective
of the Firm’s risk profile for items with market
risk that can impact the income statement. The
Consumer Lending VaR includes the Firm’s mortgage
pipeline and warehouse loans, MSRs and all related
hedges.
The revised VaR measure continues to exclude the
DVA taken on derivative and structured liabilities
to reflect the credit quality of the Firm. It also
excludes certain nontrading activity such as
Private Equity, principal investing (e.g.,
mezzanine financing, tax-oriented investments,
etc.) and Corporate balance sheet and capital
management positions, as well as longer-term
corporate investments. Corporate positions are
managed through the Firm’s earnings-at-risk and
other cash flow monitoring processes rather than by
using a VaR measure. Nontrading principal investing
activities and Private Equity positions are managed
using stress and scenario analyses.
Changing to the 95% confidence interval caused the
average VaR to drop by $85 million in the third
quarter when the new measure was implemented. Under
the 95% confidence interval, the Firm would expect
to incur daily losses greater than those predicted
by VaR estimates about twelve times a year.
The following table provides information about the
sensitivity of DVA to a one basis point increase in
JPMorgan Chase’s credit spreads. The sensitivity of
DVA at December 31, 2008, represents the Firm
(including Bear Stearns), while the sensitivity of
DVA for December 31, 2007, represents heritage
JPMorgan Chase only.
Loss advisories and drawdowns are tools used to
highlight to senior management trading losses
above certain levels and initiate discussion of
remedies.
Economic value stress testing
While VaR reflects the risk of loss due to adverse
changes in normal markets, stress testing captures
the Firm’s exposure to unlikely but plausible
events in abnormal markets. The Firm conducts
economic value stress tests for both its trading
and nontrading activities at least every two weeks
using multiple scenarios that assume credit spreads
widen significantly, equity prices decline and
interest rates rise in the major currencies.
Additional scenarios focus on the risks predominant
in individual business segments and include
scenarios that focus on the potential for adverse
moves in complex portfolios. Periodically,
scenarios are reviewed and updated to reflect
changes in the Firm’s risk profile and economic
events. Along with VaR, stress testing is
important in measuring and controlling risk. Stress
testing enhances the understanding of the Firm’s
risk profile and loss potential, and stress losses
are monitored against limits. Stress testing is
also utilized in one-off approvals and
cross-business risk measurement, as well as an
input to economic capital allocation. Stress-test
results, trends and explanations are provided at
least every two weeks to the Firm’s senior
management and to the lines of business to help
them better measure and manage risks and
understand event risk-sensitive positions.
Earnings-at-risk stress testing
The VaR and stress-test measures described above
illustrate the total economic sensitivity of the
Firm’s balance sheet to changes in market
variables. The effect of interest rate exposure on
reported net income is also important. Interest
rate risk exposure in the Firm’s core non-trading
business activities (i.e., asset/liability
management positions) results from on- and
off-balance sheet positions and can occur due to a
variety of factors, including:
•
Differences in the timing among the maturity or repricing of assets, liabilities and
off-balance sheet
instruments. For example, if liabilities reprice quicker than assets and funding interest
rates are declining, earnings will increase initially.
•
Differences in the amounts of assets, liabilities and off-balance sheet instruments
that are repricing at the same time. For example, if more deposit liabilities are
repricing than assets when general interest rates are declining, earnings will increase
initially.
•
Differences in the amounts by which short-term and long-term market interest rates
change (for example, changes in the slope of the yield curve because the Firm has the
ability to lend at long-term fixed rates and borrow at variable or short-term fixed rates.
Based upon these scenarios, the Firm’s earnings would be affected negatively by a sudden
and unanticipated increase in short-term rates paid on its liabilities (e.g., deposits)
without a corresponding increase in long-term rates received on its assets (e.g., loans).
Conversely, higher long-term rates received on assets generally are beneficial to
earnings, particularly when the increase is not accompanied by rising short-term rates
paid on liabilities.
•
The impact of changes in the maturity of various assets, liabilities or off-balance
sheet instruments as interest rates change. For example, if more borrowers than forecasted
pay down higher rate loan balances when general interest rates are declining, earnings may
decrease initially.
The Firm manages interest rate exposure related to
its assets and liabilities on a consolidated,
corporate-wide basis. Business units transfer their
interest rate risk to Treasury through a
transfer-pricing system, which takes into account
the elements of interest rate exposure that can be
risk-managed in financial markets. These elements
include asset and liability balances and
contractual rates of interest, contractual
principal payment schedules, expected prepayment
experience, interest rate reset dates and
maturities, rate indices used for re-pricing, and
any interest rate ceilings or floors for adjustable
rate products. All transfer-pricing assumptions are
dynamically reviewed.
The Firm conducts simulations of changes in net
interest income from its nontrading activities
under a
variety of interest rate scenarios.
Earnings-at-risk tests measure the potential change
in the Firm’s net interest income, and the
corresponding impact to the Firm’s pre-
tax earnings, over the following 12 months.
These tests highlight exposures to various
rate-sensitive factors, such as the rates
themselves (e.g., the prime lending rate), pricing
strategies on deposits, optionality and changes in
product mix. The tests include forecasted balance
sheet changes, such as asset sales and
securitizations, as well as prepayment and
reinvestment behavior.
Immediate changes in interest rates present a
limited view of risk, and so a number of
alternative scenarios are also reviewed. These
scenarios include the implied forward curve,
nonparallel rate shifts and severe interest rate
shocks on selected key rates. These scenarios are
intended to provide a comprehensive view of
JPMorgan Chase’s earnings-at-risk over a wide range
of outcomes.
JPMorgan Chase’s 12-month pretax earnings
sensitivity profile as of December 31, 2008 and
2007, is as follows.
Down 100 and 200 basis point parallel shocks result in a Fed Funds target rate of
zero, and negative three- and six-month Treasury rates. The earnings-at-risk results of
such a low probability scenario are not meaningful (“NM”).
The change in earnings-at-risk from December31, 2007, results from a higher level of AFS
securities and lower market interest rates. The benefit to the Firm of an increase in rates results from a widening of deposit margins which are currently compressed due to very low short term interest rates. This benefit would be partially offset by the effect of reduced mortgage prepayments. The impact to the
Firm’s pretax earnings of reduced mortgage prepayments would become more pronounced under a +200 bp parallel shock.
Additionally, another sensitivity involving a
steeper yield curve, with long-term rates rising
100 basis points and short-term rates staying at
current levels, results in a 12-month pretax
earnings benefit of $740 million. The increase in
earnings is due to reinvestment of maturing assets
at the higher long-term rates with funding costs
remaining unchanged.
Risk identification for large exposures (“RIFLE”)
Individuals who manage risk positions,
particularly those that are complex, are
responsible for identifying potential losses that
could arise from specific, unusual events, such as
a potential tax change, and estimating the
probabilities of losses arising from such events.
This information is entered into the Firm’s RIFLE
database. Management of trading businesses control
RIFLE entries, thereby permitting the Firm to
monitor further earnings vulnerability not
adequately covered by standard risk measures.
Risk monitoring and control
Limits
Market risk is controlled primarily through a
series of limits. Limits reflect the Firm’s risk
appetite in the context of the market environment
and business strategy. In setting limits, the Firm
takes into consideration factors such as market
volatility, product liquidity, business trends and
management experience.
Market risk management regularly reviews and
updates risk limits. Senior management, including
the Firm’s Chief Executive Officer and Chief Risk
Officer, is responsible for reviewing and approving
risk limits at least once a year.
The Firm maintains different levels of limits.
Corporate-level limits include VaR and stress
limits. Similarly, line-of-business limits include
VaR and stress limits and may be supplemented by
loss advisories, nonstatistical measurements and
instrument authorities. Businesses are responsible
for adhering to established limits, against which
exposures are monitored and reported. Limit
breaches are reported in a timely manner to senior
management, and the affected business segment is
required to reduce trading positions or consult
with senior management on the appropriate action.
Qualitative review
The Market Risk Management group also performs
periodic reviews as necessary of both businesses
and products with exposure to market risk to assess
the ability of the businesses to control their
market risk. Strategies, market conditions, product
details and risk controls are reviewed, and
specific recommendations for improvements are made
to management.
Model review
Some of the Firm’s financial instruments cannot be
valued based upon quoted market prices but are
instead valued using pricing models. Such models
are used for management of risk positions, such as
reporting against limits, as well as for valuation.
The Model Risk Group, independent of the businesses
and market risk management, reviews the models the
Firm uses and assesses model appropriateness and
consistency. The model reviews consider a number of
factors about the model’s suitability for valuation
and risk management of a particular product,
including whether it accurately reflects the
characteristics of the transaction and its
significant risks, the suitability and convergence
properties of numerical algorithms, reliability of
data sources, consistency of the treatment with
models for similar products, and sensitivity to
input parameters and assumptions that cannot be
priced from the market.
Reviews are conducted of new or changed models, as
well as previously accepted models, to assess
whether there have been any changes in the product
or market that may impact the model’s validity and
whether there are theoretical or competitive
developments that may require reassessment of the
model’s adequacy. For a summary of valuations based
upon models, see Critical Accounting Estimates used
by the Firm on pages 107–111 of this Annual
Report.
Risk reporting
Nonstatistical exposures, value-at-risk, loss
advisories and limit excesses are reported daily
for each trading and nontrading business. Market
risk exposure trends, value-at-risk trends, profit
and loss changes, and portfolio concentrations are
reported weekly. Stress-test results are reported
at least every two weeks to business and senior
management.
Risk management
The Firm makes direct principal investments in
private equity. The illiquid nature and long-term
holding period associated with these investments
differentiates private equity risk from the risk of
positions held in the trading portfolios. The
Firm’s approach to managing private equity risk is
consistent with the Firm’s general risk governance
structure. Controls are in place establishing
expected levels for total and annual investment in
order to control the overall size of the portfolio.
Industry and geographic concentration limits are in
place and intended to ensure diversification of the
portfolio. All invest-
ments are approved by an
investment committee that includes executives who
are not part of the investing businesses. An
independent valuation function is responsible for
reviewing the appropriateness of the carrying
values of private equity investments in accordance
with relevant accounting policies. At December 31,2008 and 2007, the carrying value of the private
equity businesses was $6.9 billion and
$7.2 billion, respectively, of which $483 million
and $390 million, respectively, represented
publicly traded positions. For further
information on the Private equity portfolio, see
page 63 of this Annual Report.
OPERATIONAL RISK MANAGEMENT
Operational risk is the risk of loss resulting
from inadequate or failed processes
or systems, human factors or external events.
Overview
Operational risk is inherent in each of the Firm’s
businesses and support activities. Operational risk
can manifest itself in various ways, including
errors, fraudulent acts, business interruptions,
inappropriate behavior of employees, or vendors
that do not perform in accordance with their
arrangements. These events could result in
financial losses and other damage to the Firm,
including reputational harm.
To monitor and control operational risk, the Firm
maintains a system of comprehensive policies and a
control framework designed to provide a sound and
well-controlled operational environment. The goal
is to keep operational risk at appropriate levels,
in light of the Firm’s financial strength, the
characteristics of its businesses, the markets in
which it operates, and the competitive and
regulatory environment to which it is subject.
Notwithstanding these control measures, the Firm
incurs operational losses.
The Firm’s approach to operational risk management
is intended to mitigate such losses by
supplementing traditional control-based approaches
to operational risk with risk measures, tools and
disciplines that are risk-specific, consistently
applied and utilized firmwide. Key themes are
transparency of information, escalation of key
issues and accountability for issue resolution.
The Firm’s operational risk framework is supported
by Phoenix, an internally designed operational risk
software tool. Phoenix integrates the individual
components of the operational risk management
framework into a unified, web-based tool. Phoenix
enhances the capture, reporting and analysis of
operational risk data by enabling risk
identification, measurement, monitoring, reporting
and analysis to be done in an integrated manner,
thereby enabling efficiencies in the Firm’s
monitoring and management of its operational risk.
For purposes of identification, monitoring,
reporting and analysis, the Firm categorizes
operational risk events as follows:
•
Client service and selection
•
Business practices
•
Fraud, theft and malice
•
Execution, delivery and process management
•
Employee disputes
•
Disasters and public safety
•
Technology and infrastructure failures
Risk identification and measurement
Risk identification is the recognition of the
operational risk events that management believes
may give rise to operational losses. All businesses
utilize the Firm’s standard self-assessment process
and supporting architecture as a dynamic risk
management tool. The goal of the self-assessment
process is for each business to identify the key
operational risks specific to its environment and
assess the degree to which it maintains appropriate
controls. Action plans are developed for control
issues identified, and businesses are held
accountable for tracking and resolving these issues
on a timely basis.
Risk monitoring
The Firm has a process for monitoring operational
risk-event data, permitting analysis of errors and
losses as well as trends. Such analysis, performed
both at a line-of-business level and by risk-event
type, enables identification of the causes
associated with risk events faced by the
businesses. Where available, the internal data can
be supplemented with external data for comparative
analysis with industry patterns. The data reported
enables the Firm to back-test against
self-assessment results. The Firm is a founding
member of
the Operational Riskdata eXchange Association, a
not-for-profit industry association formed for the
purpose of collecting operational loss data,
sharing data in an anonymous form and benchmarking
results back to members. Such information
supplements the Firm’s ongoing operational risk
measurement and analysis.
Risk reporting and analysis
Operational risk management reports provide timely
and accurate information, including information
about actual operational loss levels and
self-assessment results, to the lines of business
and senior management. The purpose of these reports
is to enable management to maintain operational
risk at appropriate levels within each line of
business, to escalate issues and to provide
consistent data aggregation across the Firm’s
businesses and support areas.
Audit alignment
Internal Audit utilizes a risk-based program of
audit coverage to provide an independent assessment
of the design and effectiveness of key controls
over the Firm’s operations, regulatory compliance
and reporting. This includes reviewing the
operational risk framework, the effectiveness and
accuracy of the business self-assessment process
and the loss data collection and reporting
activities.
REPUTATION AND FIDUCIARY RISK MANAGEMENT
A firm’s success depends not only on its
prudent management of the liquidity, credit, market
and operational risks that are part of its business
risks, but equally on the maintenance among many
constituents — clients, investors, regulators, as
well as the general public — of a reputation for
business practices of the highest quality.
Attention to reputation always has been a key
aspect of the Firm’s practices, and maintenance of
the Firm’s reputation is the responsibility of
everyone at the Firm. JPMorgan Chase bolsters this
individual responsibility in many ways, including
through the Firm’s Code of Conduct, training,
maintaining adherence to policies and procedures,
and oversight functions that approve transactions.
These oversight functions include a Conflicts
Office, which examines wholesale transactions with
the potential to create conflicts of interest for
the Firm, and regional reputation risk review
committees, which review certain transactions with
clients, especially complex derivatives and
structured finance transactions, that have the
potential to affect adversely the Firm’s
reputation. These regional committees, whose
members are senior representatives of businesses
and control functions in the region, focus on the
purpose and effect of the transactions from the
client’s point of view, with the goal that these
transactions are not used to mislead investors or
others.
Fiduciary risk management
The risk management committees within each line of
business include in their mandate the oversight of
the legal, reputational and, where appropriate,
fiduciary risks in their businesses that may
produce significant losses or reputational damage.
The Fiduciary Risk Management function works with
the relevant line-of-business risk committees with
the goal of ensuring that businesses providing
investment or risk management products or services
that give rise to fiduciary duties to clients
perform at the appropriate standard relative to
their fiduciary relationship with a client. Of
particular focus are the policies and practices
that address a business’ responsibilities to a
client, including client suitability determination;
disclosure obligations and communications; and
performance expectations with respect to risk
management products or services being provided. In
this way, the relevant line-of-business risk
committees, together with the Fiduciary Risk
Management function, provide oversight of the
Firm’s efforts to monitor, measure and control the
risks that may arise in the delivery of the
products or services to clients that give rise to
such fiduciary duties, as well as those stemming
from any of the Firm’s fiduciary responsibilities
to employees under the Firm’s various employee
benefit plans.
JPMorgan Chase’s accounting policies and use of
estimates are integral to understanding its
reported results. The Firm’s most complex
accounting estimates require management’s judgment
to ascertain the value of assets and
liabilities. The Firm has established detailed
policies and control procedures intended to ensure
that valuation methods, including any judgments
made as part of such methods, are well-controlled,
independently reviewed and applied consistently
from period to period. In addition, the policies
and procedures are intended to ensure that the
process for changing methodologies occurs in an
appropriate manner. The Firm believes its estimates
for determining the value of its assets and
liabilities are appropriate. The following is a
brief description of the Firm’s critical accounting
estimates involving significant valuation
judgments.
Allowance for credit losses
JPMorgan Chase’s allowance for credit losses covers
the wholesale and consumer loan portfolios, as well
as the Firm’s portfolio of lending-related
commitments. The allowance for credit losses is
intended to adjust the value of the Firm’s loan
assets for probable credit losses as of the balance
sheet date. For further discussion of the
methodologies used in establishing the Firm’s
allowance for credit losses, see Note 15 on pages
166–168 of this Annual Report.
Wholesale loans and lending-related commitments
The methodology for calculating both the allowance
for loan losses and the allowance for
lending-related commitments involves significant
judgment. First and foremost, it involves the
early identification of credits that are
deteriorating. Second, it involves judgment in
establishing the inputs used to estimate the
allowances. Third, it involves management judgment
to evaluate certain macroeconomic factors,
underwriting standards, and other relevant
internal and external factors affecting the credit
quality of the current portfolio and to refine
loss factors to better reflect these conditions.
The Firm uses a risk-rating system to determine the
credit quality of its wholesale loans. Wholesale
loans are reviewed for information affecting the
obligor’s ability to fulfill its obligations. In
assessing the risk rating of a particular loan,
among the factors considered are the obligor’s debt
capacity and financial flexibility, the level of
the obligor’s earnings, the amount and sources for
repayment, the level and nature of contingencies,
management strength and the industry and geography
in which the obligor operates. These factors are
based upon an evaluation of historical and current
information, and involve subjective assessment and
interpretation. Emphasizing one factor over another
or considering additional factors could impact the
risk rating assigned by the Firm to that loan.
The Firm applies its judgment to establish loss
factors used in calculating the allowances.
Wherever possible, the Firm uses independent,
verifiable data or the Firm’s own historical loss
experience in its models for estimating the
allowances. Many factors can affect estimates of
loss, including volatility of loss given default,
probability of default and rating migrations.
Consideration is given as to whether the loss
estimates should be calculated as an average over
the entire credit
cycle or at a particular point in the credit cycle,
as well as to which external data should be used
and when they should be used. Choosing data that
are not reflective of the Firm’s specific loan
portfolio characteristics could also affect loss
estimates. The application of different inputs
would change the amount of the allowance for credit
losses determined appropriate by the Firm.
Management also applies its judgment to adjust the
loss factors derived, taking into consideration
model imprecision, external factors and economic
events that have occurred but are not yet reflected
in the loss factors by establishing ranges using
historical experience of both loss given default
and probability of default. Factors related to
concentrated and deteriorating industries also are
incorporated where relevant. These estimates are
based upon management’s view of uncertainties that
relate to current macroeconomic and political
conditions, quality of underwriting standards and
other relevant internal and external factors
affecting the credit quality of the current
portfolio.
As noted on page 84 of this Annual Report, the
Firm’s wholesale allowance is sensitive to the risk
rating assigned to a loan. Assuming a one-notch
downgrade in the Firm’s internal risk ratings for
its entire wholesale
portfolio, the allowance for loan losses for the
wholesale portfolio would increase by approximately
$1.8 billion as of December 31, 2008. This
sensitivity analysis is hypothetical. In the Firm’s
view, the likelihood of a one-notch downgrade for
all wholesale loans within a short timeframe is
remote. The purpose of this analysis is to provide
an indication of the impact of risk ratings on the
estimate of the allowance for loan losses for
wholesale loans. It is not intended to imply
management’s expectation of future deterioration in
risk ratings. Given the process the Firm follows in
determining the risk ratings of its loans,
management believes the risk ratings currently
assigned to wholesale loans are appropriate.
Consumer loans and lending-related commitments
The allowance
for credit losses for the consumer portfolio is sensitive to changes in the
economic environment, delinquency status, credit
bureau scores, the realizable value of collateral,
borrower behavior and other risk factors, and is
intended to represent management’s best estimate of
incurred losses as of the balance sheet date. The credit performance of the consumer portfolio
across the entire consumer credit product spectrum
continues to be negatively affected by the economic
environment, as the weak labor market and weak
overall economic conditions have resulted in
increased delinquencies, while continued weak
housing prices have driven a significant increase
in loss severity. Significant judgment is required to estimate the
duration and severity of the current economic
downturn, as well as its potential impact on
housing prices and the labor market. While the
allowance for credit losses is highly sensitive to
both home prices and unemployment rates, in the
current market it is difficult to estimate
how potential changes in one or both of these
factors might impact the allowance for credit
losses. For example, while both factors are
important determinants of overall allowance levels,
changes in one factor or the other may not occur at
the same rate, or changes may be directionally
inconsistent such that improvement in one factor
may offset deterioration in the other. In
addition, changes in these factors would not
necessarily be consistent across geographies or
product types. Finally, it is difficult to predict
the extent to which changes in both or either of
these factors will ultimately impact the frequency
of losses, the severity of losses, or both, and
overall loss rates are a function of both the
frequency and severity of individual loan losses.
The allowance is calculated by applying statistical
loss factors and other risk indicators to pools of
loans with similar risk characteristics to arrive
at an estimate of incurred losses in the portfolio.
Management applies judgment to the statistical loss
estimates for each loan portfolio category using
delinquency trends and other risk characteristics
to estimate charge-offs. Management utilizes
additional statistical methods and considers
portfolio and collateral valuation trends to review
the appropriateness of the primary statistical loss
estimate.
The statistical calculation is adjusted to take
into consideration model imprecision, external
factors and current economic events that have
occurred but are not yet reflected in the factors
used to derive the statistical calculation, and is
accomplished in part by analyzing the historical
loss experience for each major product segment. In
the current economic environment, it is difficult
to predict whether historical loss experience is
indicative of future loss levels. Management
applies judgment within estimated ranges in
determining this adjustment, taking into account
the numerous uncertainties inherent in the current
economic environment. The estimated ranges and the
determination of the appropriate point within the
range are based upon management’s judgment related
to uncertainties associated with current
macroeconomic and political conditions, quality of
underwriting
standards, and other relevant internal and external
factors affecting the credit quality of the
portfolio.
Fair value of financial instruments, MSRs and
commodities inventory
JPMorgan Chase carries a portion of it assets and
liabilities at fair value. The majority of such
assets and liabilities are carried at fair value
on a recurring basis. In addition, certain assets
are carried at fair value on a nonrecurring
basis, including loans accounted for at the lower
of cost or fair value that are only subject to
fair value adjustments under certain
circumstances.
On January 1, 2007, the Firm adopted SFAS 157,
which established a three-level valuation hierarchy
for disclosure of fair value measurements. An
instrument’s categorization within the hierarchy is
based upon the lowest level of input that is
significant to the fair value measurement.
Therefore, for instruments classified in levels 1
and 2 of the hierarchy, where inputs are
principally based on observable market data, there
is less judgment applied in arriving at a fair
value measurement. For instruments classified
within level 3 of the hierarchy, judgments are more
significant. The Firm reviews and updates the fair
value hierarchy classifications on a quarterly basis.
Changes from one quarter to the next related to the
observability of inputs to a fair value measurement
may result in a reclassification between hierarchy
levels.
The table that follows includes the Firm’s assets carried at fair value and the portion of such
assets that are classified within level 3 of the valuation hierarchy.
Total assets carried at fair value
on a recurring basis
786.4
130.3
635.5
71.3
Total assets carried at fair value
on a nonrecurring basis(c)
11.0
4.3
14.9
11.8
Total assets carried at fair value
$
797.4
$
134.6
(f)
$
650.4
$
83.1
Less: level 3 assets for which the Firm does not
bear economic
exposure(d)
21.2
Total level 3 assets for which the Firm bears
economic exposure
$
113.4
Total Firm assets
$
2,175.1
$
1,562.1
Level 3 assets as a percentage of total Firm assets
6
%
5
%
Level 3 assets for which the Firm bears economic
exposure
as a percentage of total Firm assets
5
Level 3 assets as a percentage of total Firm
assets at fair value
17
13
Level 3 assets for which the Firm bears economic
exposure
as a percentage of total assets at fair value
14
(a)
Includes physical commodities carried at the lower of cost or fair value.
(b)
Includes certain securities purchased under resale agreements, certain securities
borrowed and certain other investments.
(c)
Predominantly consists of debt financing and other loan warehouses held-for-sale
and other assets.
(d)
Balances for which the Firm did not bear economic exposure at
December 31, 2007, were not significant.
(e)
The Firm does not allocate the FIN 39 netting adjustment across the levels of the
fair value hierarchy. As such, the level 3 derivative receivables balance included in the
level 3 total balance is reported gross of any netting adjustments.
(f)
Included in the table above are $95.1 billion of level 3 assets, consisting of
recurring and nonrecurring assets, carried by IB at December 31, 2008. This includes $21.2
billion of assets for which the Firm serves as an intermediary between two parties and
does not bear economic exposure.
Valuation
For instruments classified within level 3 of the
hierarchy, judgments may be significant. In
arriving at an estimate of fair value for an
instrument within level 3, management must first
determine the appropriate model to use. Second, due
to the lack of observability of
significant inputs, management must assess all
relevant empirical data in deriving valuation
inputs including but not limited to yield curves,
interest rates, volatilities, equity or debt
prices, foreign exchange rates and credit curves.
In addition to market information, models also
incorporate transaction details, such as maturity.
Finally,
management judgment must be applied to assess the
appropriate level of valuation adjustments to
reflect counterparty credit quality, the Firm’s
creditworthiness, constraints on liquidity and
unobservable parameters, where relevant. The
judgments made are typically affected by the type
of product and its specific contractual terms and
the level of liquidity for the product or within
the market as a whole.
Imprecision in estimating unobservable market
inputs can impact the amount of revenue or loss
recorded for a particular position. Furthermore,
while the Firm believes its valuation methods are
appropriate and consistent with those of other
market participants, the use of different
methodologies or assumptions to determine the fair
value of certain financial instruments could result
in a different estimate of fair value at the
reporting date. For a detailed discussion of the
determination of fair value for individual
financial instruments, see Note 4 on pages 129–133
of this Annual Report. In addition, for a further
discussion of the significant judgments and
estimates involved in the determination of the
Firm’s mortgage-related exposures, see “Mortgage-related exposures carried at fair value” in Note 4
on pages 139–141 of this Annual Report.
Purchased credit-impaired loans
JPMorgan Chase acquired, in connection with the
Washington Mutual transaction, certain loans with
evidence of deterioration of credit quality since
origination and for which it was probable, at
acquisition, that the Firm would be unable to
collect all contractually required payments
receivable. These purchased credit-impaired loans
are accounted for in accordance with SOP 03-3. Many
of the assumptions and estimates underlying the
application of SOP 03-3 are both significant and
judgmental, particularly considering the current
economic environment. The level of future home
price declines, the duration and severity of the
current economic downturn and the lack of market
liquidity and transparency are factors that have
impacted and may continue to impact these
assumptions and estimates.
Determining which loans are included in the scope
of SOP 03-3 is highly subjective and requires the
application of significant judgment. In the
Washington Mutual transaction, consumer loans with
certain attributes (e.g., higher loan-to-value
ratios, borrowers with lower FICO scores,
delinquencies) were determined to be
credit-impaired, provided that those attributes
arose subsequent to loan origination.
Wholesale loans were determined to be
credit-impaired if they met the definition of an
impaired loan under SFAS 114 at the acquisition
date. Applying SOP 03-3 to the appropriate
population of loans is important because loans
that are not within the scope of SOP 03-3 are
subject to different accounting standards.
Choosing different attributes in making the
management assessment of which loans were
credit-impaired and within the scope of SOP 03-3
could have resulted in a different (i.e., larger
or smaller) population of loans deemed
credit-impaired at the transaction date.
Loans determined to be within the scope of SOP
03-3 are initially recorded at fair value. The
Firm has estimated the fair value of these loans
by discounting the cash flows expected to be
collected at a market observable discount rate, when available,
adjusted for factors that a market participant
would consider in determining fair value. The
initial estimate of cash flows expected to be
collected entails significant management judgment,
as such cash flows were derived from assumptions
such as default rates, loss severities and the
amount and timing of prepayments. Particularly in
the current economic environment, estimating the
initial fair value of these loans was highly
subjective. The application of different
assumptions by management would have resulted in
different initial fair values.
The Firm has elected to aggregate the purchased
credit-impaired consumer loans into pools of loans
with common risk characteristics. Significant
judgment is required in evaluating whether
individual loans have common risk characteristics
for purposes of establishing these pools. Each
resulting pool is considered one loan with a
composite interest rate and estimation of cash
flows expected to be collected for purposes of
applying SOP 03-3 subsequent to acquisition. The
process of estimating cash flows expected to be
collected subsequent to acquisition is both
subjective and judgmental and may have an impact on
the recognition and measurement of impairment
losses and/or interest income. In addition, the
decision to pool these loans and the manner in
which they were pooled may have an impact on the
recognition, measurement and/or classification of
interest income and/or impairment losses.
Goodwill impairment
Under SFAS 142, goodwill must be allocated to
reporting units and tested for impairment. SFAS 142
defines reporting units of an entity as either SFAS
131 operating segments (i.e., one level below the
SFAS 131 reportable segments as disclosed in Note
37 of this Annual Report) or one level below the
SFAS 131 operating segments. JPMorgan Chase
generally determined its reporting units to be one
level below the six major business segments
identified in Note 37 on pages 214–215 of this
Annual Report, plus Private Equity which is
included in Corporate. This determination was based
on how the Firm’s operating segments are managed
and how they are reviewed by the Firm’s Operating
Committee.
The Firm tests goodwill for impairment at least
annually
or more frequently if events or circumstances, such
as adverse changes in the business climate,
indicate that there may be justification for
conducting an interim test. The first part of the
test is a comparison, at the reporting unit level,
of the fair value of each reporting unit to its
carrying amount, including goodwill. If the fair
value is less than the carrying value, then the
second part of the test is needed to measure the
amount of potential goodwill impairment. The
implied fair value of the reporting unit goodwill
is calculated and compared with the carrying amount
of goodwill recorded in the Firm’s financial
records. If the carrying value of the reporting
unit goodwill exceeds the implied fair value of
that goodwill, then the Firm would recognize an
impairment loss in the amount of the difference,
which would be recorded as a charge against net
income.
If the fair value of the reporting unit in the
first part of the test is determined to be greater
than the carrying amount of the reporting unit
including goodwill, then and in accordance with
SFAS 142 goodwill is deemed not to be impaired.
During the fourth quarter of 2008, the Firm
performed its annual goodwill impairment testing
and concluded that the fair value of each of its
reporting units was in excess of their respective
carrying values including goodwill. Accordingly,
the Firm concluded that its goodwill was not
impaired at December 31, 2008.
The Firm considers discounted cash flow models
to be its primary method of determining the fair
value of its reporting units. The models project
levered cash flows for five years and use the
perpetuity growth method to calculate terminal
values. The first year’s projected cash flows are
based on the reporting units’ internal budget
forecasts for the upcoming calendar year (which are
reviewed with the Operating Committee of the Firm).
To assess the reasonableness of the valuations
derived from the discounted cash flow models, the
Firm also analyzes market-based trading and
transaction multiples, where available. These
trading and transaction comparables are used to
assess the reasonableness of the estimated fair
values, as observable market information is
generally not available.
JPMorgan Chase’s stock price, consistent with stock
prices in the broader financial services sector,
declined significantly during the last half of
2008. JPMorgan Chase’s market capitalization fell
below its recorded book value, principally during
the fourth quarter of 2008. Although the Firm
believes it is reasonable to conclude that market
capitalization could be an indicator of fair value
over time, the Firm is of the view that short-term
fluctuations in market capitalization do not
reflect the long-term fair value of its reporting
units.
Management applies significant judgment when
determining the fair value of its reporting units.
Imprecision in estimating the future cash flows of
the Firm’s reporting units as well as the
appropriate cost of equity used to discount those
cash flows can impact their estimated fair values.
If JPMorgan Chase’s common stock were to trade at the level it
was at the end of 2008 over a sustained period and weak economic market conditions
persist, these factors could indicate that the
long-term earnings
potential of the Firm’s reporting units could be
adversely affected – which could result in
supplemental impairment testing during interim
reporting periods and possible impairment of
goodwill in the future.
Income taxes
JPMorgan Chase is subject to the income tax laws of
the various jurisdictions in which it operates,
including U.S. federal, state and non-U.S.
jurisdictions. These laws are often complex and may
be subject to different interpretations. To
determine the financial statement impact of its
accounting for income taxes, including the
provision for income tax expense and its
unrecognized tax benefits, JPMorgan Chase must make
assumptions and judgments about how to interpret
and apply these complex tax laws to numerous
transactions and business events. Disputes over
interpretations with the various taxing authorities
may be settled upon audit or administrative
appeals. In some cases, the Firm’s interpretations
of tax laws may be subject to adjudication by the
court systems of the tax jurisdictions in which it
operates. JPMorgan Chase regularly reviews whether
the Firm may be assessed additional income taxes as
a result of the resolution of these matters, and
the Firm records additional reserves as
appropriate.
The Firm does not anticipate that current market
events will adversely impact the realizability of
its deferred tax assets.
The Firm adjusts its unrecognized tax benefits
as necessary when additional information becomes
available. The reassessment of JPMorgan Chase’s
unrecognized tax benefits may have a material
impact on its effective tax rate in the period
in which it occurs.
ACCOUNTING AND REPORTING DEVELOPMENTS
Derivatives netting – amendment of FASB
Interpretation No. 39
In April 2007, the FASB issued FSP FIN 39-1, which
permits offsetting of cash collateral receivables
or payables with net derivative positions under
certain circumstances. The Firm adopted FSP FIN
39-1 effective January 1, 2008. The FSP did not
have a material impact on the Firm’s Consolidated
Balance Sheets.
Accounting for income tax benefits of dividends on
share-based payment awards
In June 2007, the FASB ratified EITF 06-11, which
must be applied prospectively for dividends
declared in fiscal years beginning after December15, 2007. EITF 06-11 requires that realized tax
benefits from dividends or dividend equivalents
paid on equity-classified share-based payment
awards that are charged to retained earnings be
recorded as an increase to additional paid-in
capital and included in the pool of excess tax
benefits
available to absorb tax deficiencies on share-based
payment awards. Prior to the issuance of EITF
06-11, the Firm did not include these tax benefits
as part of this pool of excess tax benefits. The
Firm adopted EITF 06-11 on January 1, 2008. The
adoption of this consensus did not have an impact
on the Firm’s Consolidated Balance Sheets or
results of operations.
Fair value measurements – written loan commitments
In November 2007, the SEC issued SAB 109, which
revises and rescinds portions of SAB 105.
Specifically, SAB 109 states that the expected net
future cash flows related to the associated
servicing of the loan should be included in the
measurement of all written loan commitments that
are accounted for at fair value through earnings.
The provisions of SAB 109 are applicable to
written loan commitments issued or modified
beginning on January 1, 2008. The Firm adopted SAB
109 on January 1, 2008. The adoption of this
pronouncement did not have a material impact on
the Firm’s Consolidated Balance Sheets or results
of operations.
Business combinations/noncontrolling interests in
consolidated financial statements
In December 2007, the FASB issued SFAS 141R and
SFAS 160, which amend the accounting and reporting
of business combinations, as well as noncontrolling
(i.e., minority) interests. For JPMorgan Chase,
SFAS 141R is effective for business combinations
that close on or after January 1, 2009. SFAS 160 is
effective for JPMorgan Chase for fiscal years
beginning on or after December 15, 2008.
SFAS 141R will generally only impact the
accounting for future business combinations and
will impact certain aspects of business combination
accounting, such as transaction costs and certain
merger-related restructuring reserves, as well as
the accounting for partial acquisitions where
control is obtained by JPMorgan Chase. One
exception to the prospective application of SFAS
141R relates to accounting for income taxes
associated with business combinations that closed
prior to January 1, 2009. Once the purchase
accounting measurement period closes for these
acquisitions, any further adjustments to income
taxes recorded as part of these business
combinations will impact income tax expense.
Previously, further adjustments were predominately
recorded as adjustments to Goodwill. JPMorgan Chase
will continue to evaluate the impact that SFAS 141R
will have on its consolidated financial statements.
SFAS 160 requires that noncontrolling interests be
accounted for and presented as equity, rather than
as a liability or mezzanine equity. Changes to how
the income statement is presented will also result.
SFAS 160 presentation and disclosure requirements
are to be
applied retrospectively. The adoption of this
pronouncement is not expected to have a material
impact on the Firm’s Consolidated Balance Sheets,
results of operations or ratios.
Accounting for transfers of financial assets and
repurchase financing transactions
In February 2008, the FASB issued FSP FAS 140-3,
which requires an initial transfer of a financial
asset and a repurchase financing that was entered
into contempora-neously with, or in contemplation
of, the initial transfer to be evaluated together
as a linked transaction under SFAS 140, unless
certain criteria are met. The Firm adopted FSP FAS
140-3 on January 1, 2009, for new transactions
entered into after the date of adoption. The
adoption of FSP FAS 140-3 is not expected to have a
material impact on the Consolidated Balance Sheets
or results of operations.
Disclosures about derivative instruments and
hedging activities – FASB Statement No. 161
In March 2008, the FASB issued SFAS 161, which
amends the disclosure requirements of SFAS 133.
SFAS 161 requires increased disclosures about
derivative instruments and hedging activities and
their effects on an entity’s financial position,
financial performance and cash flows. SFAS 161 is
effective for fiscal years beginning after November15, 2008, with early adoption permitted. SFAS 161
will only affect JPMorgan Chase’s disclosures of
derivative instruments and related hedging
activities, and not its Consolidated Balance
Sheets, Consolidated Statements of Income or
Consolidated Statements of Cash Flows.
Determining whether instruments granted in
share-based payment transactions are
participating securities
In June 2008, the FASB issued FSP EITF 03-6-1,
which addresses whether instruments granted in
share-based payment transactions are participating
securities prior to vesting and, therefore, need to
be included in the earnings allocation in computing
earnings per share under the two-class method. FSP
EITF 03-6-1 is effective for financial statements
issued for fiscal years beginning after December15, 2008, and interim periods within those years.
Adoption of FSP EITF
03-6-1 does not affect net income or results of
operations but may result in a reduction of basic
and/or diluted earnings per share in certain
periods.
Disclosures about credit derivatives and certain guarantees
In September 2008, the FASB issued FSP FAS 133-1
and FIN 45-4. The FSP requires enhanced disclosures
about credit derivatives and guarantees to address
the potential adverse effects of changes in credit
risk on the financial position, financial
performance and cash flows of the sellers of these
instruments. The FSP is effective for reporting
periods ending after November 15, 2008, with
earlier application permitted. The disclosures required by this FSP are incorporated in this Annual Report. FSP FAS 133-1 and
FIN 45-4 only affects JPMorgan Chase’s
disclosures of credit derivatives and guarantees
and not its Consolidated
Balance Sheets, Consolidated Statements of Income
or Consolidated
Statements of Cash Flows.
Determining whether an instrument (or embedded
feature) is indexed to an entity’s own stock
In September 2008, the EITF issued EITF 07-5, which
establishes a two-step process for evaluating
whether equity-linked financial instruments and
embedded features are indexed to a company’s own
stock for purposes of determining whether the
derivative scope exception in SFAS 133 should be
applied. EITF 07-5 is effective for fiscal years
beginning after December 2008. The adoption of this
EITF is not expected to have a material impact on
the Firm’s Consolidated Balance Sheets or results
of operations.
Accounting for transfers of financial assets and
consolidation of variable interest entities
The FASB has been deliberating certain amendments
to both SFAS 140 and FIN 46R that may impact the
accounting for transactions that involve QSPEs and
VIEs. Among other things, the FASB is proposing to
eliminate the concept of QSPEs from both SFAS 140
and FIN 46R and make key changes to the
consolidation model of FIN 46R that will change the
method of determining which party to a VIE should
consolidate the VIE. A final standard is
expected to be issued in the second quarter of
2009, with an
expected
effective date in January 2010. Entities expected to be impacted
include revolving securitization entities, bank-administered
asset-backed commercial paper conduits, and certain mortgage
securitization entities. The Firm is monitoring the FASB’s
deliberations on these proposed amendments and continues to evaluate
their potential impact. The ultimate impact to the Firm will depend
upon the guidance issued by the FASB in a final statement amending
SFAS 140 and FIN 46R.
Determining the fair value of an asset when the
market for that asset is not active
In October 2008, the FASB issued FSP FAS 157-3,
which clarifies the application of SFAS 157 in a
market that is not active and provides an example
to illustrate key considerations in determining the
fair value of a financial instrument when the
market for that financial asset is not active. The
FSP was effective upon issuance, including prior
periods for which financial statements have not
been issued. The application of this FSP did not
have an impact on the Firm’s Consolidated Balance
Sheets or results of operations.
Disclosure about transfers of financial assets and
interests in VIEs
On December 11, 2008, the FASB issued FSP FAS 140-4
and FIN 46(R)-8, which requires additional
disclosures relating to transfers of financial
assets and interests in
securitization entities and other variable interest
entities. The purpose of this FSP is to require
improved disclosure by public enterprises prior to
the effective dates of the proposed amendments to
SFAS 140 and FIN 46(R). The effective date for the
FSP is for reporting periods (interim and
annual) beginning with the first reporting period
that ends after December 15, 2008. The disclosures
required by this FSP are incorporated in this
Annual Report. FSP SFAS 140-4 and FIN 46(R)-8 only affects JPMorgan Chase’s disclosure of
transfers of financial assets and interests in
securitization entities and other variable interest
entities and not its Consolidated Balance Sheets,
Consolidated Statements of Income or Consolidated
Statements of Cash Flows.
Employers’ disclosures about postretirement
benefit plan assets
In December 2008, the FASB issued FSP FAS 132(R)-1,
which requires more detailed disclosures about
employers’ plan assets, including investment
strategies, major categories of plan assets,
concentrations of risk within plan assets, and
valuation techniques used to measure the fair value
of plan assets. This FSP is effective for fiscal
years ending after December 15, 2009. The Firm
intends to adopt these additional disclosure
requirements on the effective date.
Amendments
to the impairment guidance of EITF Issue No.
99-20
In January 2009, the FASB issued FSP EITF 99-20-1,
which amends the impairment guidance in EITF 99-20
to make the investment security impairment model in
EITF 99-20 more consistent with the securities
impairment model in SFAS 115. FSP EITF 99-20-1
removes the requirement that a holder’s best
estimate of cash flows be based exclusively upon
those that a market participant would use and
allows for reasonable judgment to be applied in
considering whether an adverse change in cash flows
has occurred based on all available information
relevant to the collectibility of the security. FSP
EITF 99-20-1 is effective for interim and annual periods ending after
December 15, 2008, and therefore the Firm has adopted FSP EITF 99-20-1
as of December 31, 2008. The adoption of this
FSP did not have a material impact on the Firm’s
Consolidated Balance Sheets or results of
operations.
NONEXCHANGE-TRADED COMMODITY DERIVATIVE CONTRACTS AT FAIR VALUE
In the normal course of business, JPMorgan
Chase trades nonexchange-traded commodity
derivative contracts. To determine the fair value
of these contracts, the Firm uses various fair
value estimation techniques, primarily based upon
internal models with significant observable market
parameters. The Firm’s nonexchange-traded
commodity derivative contracts are primarily
energy-related.
The following table summarizes the changes in fair
value for nonexchange-traded commodity derivative
contracts for the year ended December 31, 2008.
From time to time, the Firm has made and will
make forward-looking statements. These statements
can be identified by the fact that they do not
relate strictly to historical or current facts.
Forward-looking statements often use words such as
“anticipate,”“target,”“expect,”“estimate,”“intend,”“plan,”“goal,”“believe,” or other words
of similar meaning. Forward-looking statements
provide JPMorgan Chase’s current expectations or
forecasts of future events, circumstances, results
or aspirations. JPMorgan Chase’s disclosures in
this Annual Report contain forward-looking
statements within the meaning of the Private
Securities Litigation Reform Act of 1995. The Firm
also may make forward-looking statements in its
other documents filed or furnished with the SEC. In
addition, the Firm’s senior management may make
forward-looking statements orally to analysts,
investors, representatives of the media and others.
All forward-looking statements are, by their
nature, subject to risks and uncertainties, many
of which are beyond the Firm’s control. JPMorgan
Chase’s actual future results may differ
materially from those set forth in its
forward-looking statements. While there is no
assurance that any list of risks and uncertainties
or risk factors is complete, below are certain
factors which could cause actual results to differ
from those in the forward-looking statements.
•
local, regional and international business, economic and political conditions and
geopolitical events;
•
changes in trade, monetary and fiscal policies and laws;
•
securities and capital markets behavior, including changes in market liquidity and
volatility;
•
changes in investor sentiment or consumer spending or saving behavior;
•
ability of the Firm to manage effectively its liquidity;
•
credit ratings assigned to the Firm or its subsidiaries;
•
the Firm’s reputation;
•
ability of the Firm to deal effectively with an economic slowdown or other economic
or market difficulty;
•
technology changes instituted by the Firm, its counterparties or competitors;
•
mergers and acquisitions, including the Firm’s ability to integrate acquisitions;
•
ability of the Firm to develop new products and services;
•
acceptance of the Firm’s new and existing products and services by the marketplace
and the ability of the Firm to increase market share;
•
ability of the Firm to attract and retain employees;
•
ability of the Firm to control expense;
•
competitive pressures;
•
changes in the credit quality of the Firm’s customers and counterparties;
•
adequacy of the Firm’s risk management framework;
•
changes in laws and regulatory requirements or adverse judicial proceedings;
•
changes in applicable accounting policies;
•
ability of the Firm to determine accurate values of certain assets and liabilities;
•
occurrence of natural or man-made disasters or calamities or conflicts, including
any effect of any such disasters, calamities or conflicts on the Firm’s power generation
facilities and the Firm’s other commodity-related activities;
•
the other risks and uncertainties detailed in Part 1, Item 1A: Risk Factors in the
Firm’s Annual Report on Form 10-K for the year ended December 31, 2008.
Any forward-looking statements made by or on behalf
of the Firm speak only as of the date they are
made, and JPMorgan Chase does not undertake to
update forward-looking statements to reflect the
impact of circumstances or events that arise after
the date the forward-looking statement was made.
The reader should, however, consult any further
disclosures of a forward-looking nature the Firm
may make in any subsequent Annual Reports on Form
10-K, Quarterly Reports on Form 10-Q, or Current
Reports on Form 8-K.
Management’s report on internal control over financial reporting
Management of JPMorgan Chase & Co. (“JPMorgan
Chase” or the “Firm”) is responsible for
establishing and maintaining adequate internal
control over financial reporting. Internal control
over financial reporting is a process designed by,
or under the supervision of, the Firm’s principal
executive and principal financial officers, or
persons performing similar functions, and effected
by JPMorgan Chase’s Board of Directors, management
and other personnel, to provide reasonable
assurance regarding the reliability of financial
reporting and the preparation of financial
statements for external purposes in accordance with
accounting principles generally accepted in the
United States of America.
JPMorgan Chase’s internal control over financial
reporting includes those policies and procedures
that (1) pertain to the maintenance of records,
that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the
Firm’s assets; (2) provide reasonable assurance
that transactions are recorded as necessary to
permit preparation of financial statements in
accordance with generally accepted accounting
principles, and that receipts and expenditures of
the Firm are being made only in accordance with
authorizations of JPMorgan Chase’s management and
directors; and (3) provide reasonable assurance
regarding prevention or timely detection of
unauthorized acquisition, use or disposition of
the Firm’s assets that could have a material
effect on the financial statements.
Because of its inherent limitations, internal
control over financial reporting may not prevent or
detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are
subject to the risk that controls may become
inadequate because of changes in conditions, or
that the degree of compliance with the policies or
procedures may deteriorate.
Management has completed an assessment of the
effectiveness of the Firm’s internal control over
financial reporting as of December 31, 2008. In
making the assessment, management used the
framework in “Internal Control – Integrated
Framework” promulgated by the Committee of
Sponsoring Organizations of the Treadway
Commission, commonly referred to as the “COSO”
criteria.
Based upon the assessment performed, management
concluded that as of December 31, 2008, JPMorgan
Chase’s internal control over financial reporting
was effective based upon the COSO criteria.
Additionally, based upon management’s assessment,
the Firm determined that there were no material
weaknesses in its internal control over financial
reporting as of December 31, 2008.
The effectiveness of the Firm’s internal control
over financial reporting as of December 31, 2008,
has been audited by PricewaterhouseCoopers LLP, an
independent registered public accounting firm, as
stated in their report which appears herein.
Report of independent registered public accounting firm
Report of Independent Registered Public
Accounting Firm To the Board of Directors and
Stockholders of JPMorgan Chase & Co.:
In our opinion, the accompanying consolidated
balance sheets and the related consolidated
statements of income, changes in stockholders’
equity and comprehensive income and cash flows
present fairly, in all material respects, the
financial position of JPMorgan Chase & Co. and its
subsidiaries (the “Firm”) at December 31, 2008 and
2007, and the results of their operations and their
cash flows for each of the three years in the
period ended December 31, 2008 in conformity with
accounting principles generally accepted in the
United States of America. Also in our opinion, the
Firm maintained, in all material respects,
effective internal control over financial reporting
as of December 31, 2008, based on criteria
established in Internal Control – Integrated
Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).
The Firm’s management is responsible for these
financial statements, for maintaining effective
internal control over financial reporting and for
its assessment of the effectiveness of internal
control over financial reporting, included in the
accompanying “Management’s report on internal
control over financial reporting.” Our
responsibility is to express opinions on these
financial statements and on the Firm’s internal
control over financial reporting based on our
integrated audits. We conducted our audits in
accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those
standards require that we plan and perform the
audits to obtain reasonable assurance about whether
the financial statements are free of material
misstatement and whether effective internal control
over financial reporting was maintained in all
material respects. Our audits of the financial
statements included examining, on a test basis,
evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting
principles used and significant estimates made by
management, and evaluating the overall financial
statement presentation. Our audit of internal
control over financial reporting included obtaining
an understanding of internal control over financial
reporting, assessing the risk that a material
weakness exists, and testing and evaluating the
design and operating effectiveness of internal
control based on the assessed risk. Our audits also
included performing such other procedures as we
considered necessary in the circumstances. We
believe that our audits provide a reasonable basis
for our opinions.
As discussed in Note 4, Note 5, and Note 28 to the
Consolidated Financial Statements, effective
January 1, 2007 the Firm adopted Statement of
Financial Accounting Standards No. 157, “Fair Value
Measurement,” Statement of Financial Accounting
Standards No. 159, “Fair Value Option for Financial
Assets and Financial Liabilities,” and FASB
Interpretation No. 48, “Accounting for Uncertainty
in Income Taxes.”
A company’s internal control over financial
reporting is a process designed to provide
reasonable assurance regarding the reliability of
financial reporting and the preparation of
financial statements for external purposes in
accordance with generally accepted accounting
principles. A company’s internal control over
financial reporting includes those policies and
procedures that (i) pertain to the maintenance of
records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of
the assets of the company; (ii) provide reasonable
assurance that transactions are recorded as
necessary to permit preparation of financial
statements in accordance with generally accepted
accounting principles, and that receipts and
expenditures of the company are being made only in
accordance with authorizations of management and
directors of the company; and (iii) provide
reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or
disposition of the company’s assets that could have
a material effect on the financial statements.
Because of its inherent limitations, internal
control over financial reporting may not prevent or
detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are
subject to the risk that controls may become
inadequate because of changes in conditions, or
that the degree of compliance with the policies or
procedures may deteriorate.
Federal funds sold and securities purchased under resale agreements (included $20,843 and
$19,131 at fair value
at December 31, 2008 and 2007, respectively)
203,115
170,897
Securities borrowed (included $3,381 and zero at fair value at December 31, 2008 and 2007,
respectively)
124,000
84,184
Trading
assets (included assets pledged of $75,063 and $79,229 at December 31, 2008 and 2007,
respectively)
509,983
491,409
Securities (included $205,909 and $85,406 at fair value at December 31, 2008 and 2007,
respectively,
and assets pledged of $25,942 and $3,958 at December 31, 2008 and 2007, respectively)
205,943
85,450
Loans (included $7,696 and $8,739 at fair value at December 31, 2008 and 2007, respectively)
744,898
519,374
Allowance for loan losses
(23,164
)
(9,234
)
Loans, net of allowance for loan losses
721,734
510,140
Accrued interest and accounts receivable
60,987
24,823
Premises and equipment
10,045
9,319
Goodwill
48,027
45,270
Other intangible assets:
Mortgage servicing rights
9,403
8,632
Purchased credit card relationships
1,649
2,303
All other intangibles
3,932
3,796
Other assets
(included $29,199 and $22,151 at fair value at December 31, 2008 and 2007,
respectively)
111,200
74,314
Total assets
$
2,175,052
$
1,562,147
Liabilities
Deposits (included $5,605 and $6,389 at fair value at December 31, 2008 and 2007, respectively)
$
1,009,277
$
740,728
Federal funds purchased and securities loaned or sold under repurchase agreements (included
$2,993 and $5,768 at
fair value at December 31, 2008 and 2007, respectively)
192,546
154,398
Commercial paper
37,845
49,596
Other borrowed funds (included $14,713 and $10,777 at fair value at December 31, 2008 and
2007, respectively)
132,400
28,835
Trading liabilities
166,878
157,867
Accounts payable and other liabilities (including the allowance for lending-related
commitments of $659 and $850 at December 31, 2008 and 2007, respectively, and zero and $25 at
fair value at
December 31, 2008 and 2007, respectively)
187,978
94,476
Beneficial interests issued by consolidated variable interest entities (included $1,735 and
$3,004 at fair value at
December 31, 2008 and 2007, respectively)
10,561
14,016
Long-term debt (included $58,214 and $70,456 at fair value at December 31, 2008 and 2007,
respectively)
252,094
183,862
Junior subordinated deferrable interest debentures held by trusts that issued guaranteed
capital debt securities
18,589
15,148
Total liabilities
2,008,168
1,438,926
Commitments and contingencies (see Note 31 on page 201 of this Annual Report)
Common stock ($1 par value; authorized 9,000,000,000 shares at December 31, 2008 and 2007;
issued 3,941,633,895 shares and 3,657,671,234 shares at December 31, 2008 and 2007,
respectively)
3,942
3,658
Capital surplus
92,143
78,597
Retained earnings
54,013
54,715
Accumulated other comprehensive income (loss)
(5,687
)
(917
)
Shares held in RSU Trust, at cost (4,794,723 shares at December 31, 2008)
(217
)
—
Treasury stock, at cost (208,833,260 shares and 290,288,540 shares at December 31, 2008 and
2007, respectively)
(9,249
)
(12,832
)
Total stockholders’ equity
166,884
123,221
Total liabilities and stockholders’ equity
$
2,175,052
$
1,562,147
The Notes to Consolidated Financial Statements are an integral part of these statements.
Adjustments to reconcile net income to net cash (used in) provided by
operating activities:
Provision for credit losses
20,979
6,864
3,270
Depreciation and amortization
3,143
2,427
2,149
Amortization of intangibles
1,263
1,394
1,428
Deferred tax (benefit) expense
(2,637
)
1,307
(1,810
)
Investment securities (gains) losses
(1,560
)
(164
)
543
Proceeds on sale of investment
(1,540
)
—
—
Gains on disposition of businesses
(199
)
—
(1,136
)
Stock-based compensation
2,637
2,025
2,368
Originations and purchases of loans held-for-sale
(34,902
)
(116,471
)
(178,355
)
Proceeds from sales, securitizations and paydowns of loans held-for-sale
38,036
107,350
173,448
Net change in:
Trading assets
(12,787
)
(121,240
)
(61,664
)
Securities borrowed
15,408
(10,496
)
916
Accrued interest and accounts receivable
10,221
(1,932
)
(1,170
)
Other assets
(33,629
)
(21,628
)
(7,193
)
Trading liabilities
24,061
12,681
(4,521
)
Accounts payable and other liabilities
1,012
4,284
7,815
Other operating adjustments
(12,013
)
7,674
(111
)
Net cash provided by (used in) operating activities
23,098
(110,560
)
(49,579
)
Investing activities
Net change in:
Deposits with banks
(118,929
)
2,081
8,168
Federal funds sold and securities purchased under resale agreements
(44,597
)
(29,814
)
(6,939
)
Held-to-maturity securities:
Proceeds
10
14
19
Available-for-sale securities:
Proceeds from maturities
44,414
31,143
24,909
Proceeds from sales
96,806
98,450
123,750
Purchases
(248,599
)
(122,507
)
(201,530
)
Proceeds from sales and securitizations of loans held-for-investment
27,531
34,925
20,809
Other changes in loans, net
(59,123
)
(83,437
)
(70,837
)
Net cash received (used) in business acquisitions or dispositions
2,128
(70
)
185
Proceeds from assets sale to the FRBNY
28,850
—
—
Net purchases of asset-backed commercial paper guaranteed by the FRBB
(11,228
)
—
—
All other investing activities, net
(3,609
)
(3,903
)
1,839
Net cash used in investing activities
(286,346
)
(73,118
)
(99,627
)
Financing activities
Net change in:
Deposits
177,331
113,512
82,105
Federal funds purchased and securities loaned or sold under repurchase
agreements
15,250
(7,833
)
36,248
Commercial paper and other borrowed funds
9,186
41,412
12,657
Proceeds from the issuance of long-term debt and capital debt securities
72,407
95,141
56,721
Repayments of long-term debt and capital debt securities
(62,691
)
(49,410
)
(34,267
)
Excess tax benefits related to stock-based compensation
148
365
302
Proceeds from issuance of common stock
11,969
1,467
1,659
Proceeds from issuance of preferred stock and warrant to the U.S. Treasury
25,000
—
—
Proceeds from issuance of preferred stock
7,746
—
—
Redemption of preferred stock
—
—
(139
)
Repurchases of treasury stock
—
(8,178
)
(3,938
)
Cash dividends paid
(5,911
)
(5,051
)
(4,846
)
All other financing activities, net
71
1,561
6,247
Net cash provided by financing activities
250,506
182,986
152,749
Effect of exchange rate changes on cash and due from banks
(507
)
424
199
Net (decrease) increase in cash and due from banks
(13,249
)
(268
)
3,742
Cash and due from banks at the beginning of the year
40,144
40,412
36,670
Cash and due from banks at the end of the year
$
26,895
$
40,144
$
40,412
Cash interest paid
$
37,267
$
43,472
$
36,415
Cash income taxes paid
2,280
7,472
5,563
Note:
In 2008, the fair values of noncash assets acquired and liabilities assumed in the merger
with Bear Stearns were $288.2 billion and $287.7 billion, respectively; approximately 26 million
shares of common stock, valued at approximately $1.2 billion, were issued in connection with the
Bear Stearns merger. Also, in 2008 the fair values of noncash assets acquired and liabilities
assumed in the Washington Mutual transaction were $260.0 billion and $259.8 billion, respectively.
In 2006, the Firm exchanged selected corporate trust businesses for The Bank of New York’s
consumer, business banking and middle-market banking businesses. The fair values of the noncash
assets exchanged were $2.15 billion.
The Notes to Consolidated Financial Statements are an integral part of these statements.
JPMorgan Chase & Co. (“JPMorgan Chase” or the
“Firm”), a financial holding company incorporated
under Delaware law in 1968, is a leading global
financial services firm and one of the largest
banking institutions in the United States of
America (“U.S.”), with operations worldwide. The
Firm is a leader in investment banking, financial
services for consumers and businesses, financial
transaction processing and asset management. For a
discussion of the Firm’s business segment
information, see Note 37 on pages 214–215 of this
Annual Report.
The accounting and financial reporting policies of
JPMorgan Chase and its subsidiaries conform to
accounting principles generally accepted in the
United States of America (“U.S. GAAP”).
Additionally, where applicable, the policies
conform to the accounting and reporting guidelines
prescribed by bank regulatory authorities.
Certain amounts in prior periods have been
reclassified to conform to the current
presentation.
Consolidation
The Consolidated Financial Statements include the
accounts of JPMorgan Chase and other entities in
which the Firm has a controlling financial
interest. All material intercompany balances and
transactions have been eliminated.
The usual condition for a controlling financial
interest is the ownership of a majority of the
voting interests of the entity. However, a
controlling financial interest also may be deemed
to exist with respect to entities, such as
special purpose entities (“SPEs”), through
arrangements that do not involve controlling voting
interests.
SPEs are an important part of the financial
markets, providing market liquidity by facilitating
investors’ access to specific portfolios of assets
and risks. For example, they are critical to the
functioning of the mortgage- and asset-backed
securities and commercial paper markets. SPEs may
be organized as trusts, partnerships or
corporations and are typically established for a
single, discrete purpose. SPEs are not typically
operating entities and usually have a limited life
and no employees. The basic SPE structure involves
a company selling assets to the SPE. The SPE funds
the purchase of those assets by issuing securities
to investors. The legal documents that govern the
transaction specify how the cash earned on the
assets must be allocated to the SPE’s investors and
other parties that have rights to those cash flows.
SPEs are generally structured to insulate investors
from claims on the SPE’s assets by creditors of
other entities, including the creditors of the
seller of the assets.
There are two different accounting frameworks
applicable to SPEs: The qualifying SPE (“QSPE”)
framework under SFAS 140 and the variable interest
entity (“VIE”) framework under FIN 46R. The
applicable framework depends on the nature of the
entity and the Firm’s relation to that entity. The
QSPE framework is applicable when an entity
transfers (sells) financial assets to an SPE
meeting certain criteria defined in SFAS 140. These
criteria are designed to ensure that the activities
of the entity are essentially predetermined at the
inception of the vehicle and that the transferor of
the financial assets cannot exercise control over
the entity and the assets therein. Entities
meeting these criteria are not consolidated by the
transferor or other counterparties as long as they
do not have the unilateral ability to liquidate or
to cause the entity to no longer meet the QSPE
criteria. The Firm
primarily follows the QSPE model for
securitizations of its residential and commercial
mortgages, and credit card, automobile and student
loans. For further details, see Note 16 on pages
168–176 of this Annual Report.
When an SPE does not meet the QSPE criteria,
consolidation is assessed pursuant to FIN 46R.
Under FIN 46R, a VIE is defined as an entity that:
(1) lacks enough equity investment at risk to
permit the entity to finance its activities without
additional subordinated financial support from
other parties; (2) has equity owners that lack the
right to make significant decisions affecting the
entity’s operations; and/or (3) has equity owners
that do not have an obligation to absorb the
entity’s losses or the right to receive the
entity’s returns.
FIN 46R requires a variable interest holder (i.e.,
a counterparty to a VIE) to consolidate the VIE if
that party will absorb a majority of the expected
losses of the VIE, receive the majority of the
expected residual returns of the VIE, or both. This
party is considered the primary beneficiary. In
making this determination, the Firm thoroughly
evaluates the VIE’s design, capital structure
and relationships among the variable interest
holders. When the primary beneficiary cannot be
identified through a qualitative analysis, the Firm
performs a quantitative analysis, which computes
and allocates expected losses or residual returns
to variable interest holders. The allocation of
expected cash flows in this analysis is based upon
the relative rights and preferences of each
variable interest holder in the VIE’s capital
structure. The Firm reconsiders whether it is the
primary beneficiary of a VIE when certain events
occur as required by FIN 46R. For further details,
see Note 17 on pages 177–186 of this Annual
Report.
All retained interests and significant transactions
between the Firm, QSPEs and nonconsolidated VIEs
are reflected on JPMorgan Chase’s Consolidated
Balance Sheets and in the Notes to consolidated
financial statements.
Investments in companies that are considered to be
voting-interest entities under FIN 46R in which the
Firm has significant influence over operating and
financing decisions are either accounted for in
accordance with the equity method of accounting or
at fair value if elected under SFAS 159 (“Fair
Value Option”). These investments are generally
included in other assets, with income or loss
included in other income.
For a discussion of the accounting for private
equity investments, see Note 6 on pages 147–148 of
this Annual Report.
Assets held for clients in an agency or fiduciary
capacity by the Firm are not assets of JPMorgan
Chase and are not included in the Consolidated
Balance Sheets.
Use of estimates in the preparation of
consolidated financial statements
The preparation of Consolidated Financial
Statements requires management to make estimates
and assumptions that affect the reported amounts of
assets and liabilities, revenue and expense, and
disclosures
of contingent assets and liabilities. Actual results
could be different from these estimates. For
discussion of Critical Accounting Estimates used by
the Firm, see pages 107–111 of this Annual Report.
Foreign currency translation
JPMorgan Chase revalues assets, liabilities,
revenue and expense denominated in non-U.S.
currencies into U.S. dollars using applicable
exchange rates.
Gains and losses relating to translating functional
currency financial statements for U.S. reporting
are included in other comprehensive income (loss)
within stockholders’ equity. Gains and losses
relating to nonfunctional currency transactions,
including non-U.S. operations where the functional
currency is the U.S. dollar, are reported in the
Consolidated Statements of Income.
Foreclosed property
The Firm acquires property from borrowers through
loan restructurings, workouts, and foreclosures.
Property acquired may include real property (e.g.,
land, buildings, and fixtures) and personal
property
(e.g., aircraft, railcars, and ships). Acquired
property is valued at fair value less costs to
sell at acquisition. Each quarter the fair value
of the acquired property is reviewed and adjusted,
if necessary. Any adjustments to fair value in the
first 90 days are credited/charged to the
allowance for loan losses and thereafter to other
expense.
Statements of cash flows
For JPMorgan Chase’s Consolidated Statements of
Cash Flows, cash is defined as those amounts
included in cash and due from banks.
Significant accounting policies
The following table identifies JPMorgan Chase’s
other significant accounting policies and the Note
and page where a detailed description of each
policy can be found.
Fair value measurement
Note 4
Page 129
Fair value option
Note 5
Page 144
Principal transactions activities
Note 6
Page 146
Other noninterest revenue
Note 7
Page 148
Pension and other postretirement employee
benefit plans
Note 9
Page 149
Employee stock-based incentives
Note 10
Page 155
Noninterest expense
Note 11
Page 158
Securities
Note 12
Page 158
Securities financing activities
Note 13
Page 162
Loans
Note 14
Page 163
Allowance for credit losses
Note 15
Page 166
Loan securitizations
Note 16
Page 168
Variable interest entities
Note 17
Page 177
Goodwill and other intangible assets
Note 18
Page 186
Premises and equipment
Note 19
Page 189
Other borrowed funds
Note 21
Page 190
Accounts payable and other liabilities
Note 22
Page 190
Income taxes
Note 28
Page 197
Commitments and contingencies
Note 31
Page 201
Accounting for derivative instruments
and hedging activities
Note 32
Page 202
Off-balance sheet lending-related financial
instruments and guarantees
Note 33
Page 206
Note 2 – Business changes and
developments
Decrease in Common Stock Dividend
On February 23, 2009, the Board of Directors reduced the
Firm’s quarterly common stock dividend from $0.38 to $0.05 per
share, effective for the dividend payable April 30, 2009 to
shareholders of record on April 6, 2009.
Acquisition of the banking operations of
Washington Mutual Bank On September 25, 2008, JPMorgan Chase acquired the
banking operations of Washington Mutual Bank
(“Washington Mutual”) from the Federal Deposit
Insurance Corporation (“FDIC”) for $1.9 billion.
The acquisition expands JPMorgan Chase’s consumer
branch network into several states, including
California, Florida and Washington, among others.
The acquisition also extends the reach of the
Firm’s business banking, commercial banking, credit
card, consumer lending and wealth management
businesses. The acquisition was accounted for under
the purchase method of accounting in accordance
with SFAS 141.
The $1.9 billion purchase price was allocated to
the Washington Mutual assets acquired and
liabilities assumed using preliminary allocated
values as of
September 25, 2008, which resulted in negative
goodwill. The initial allocation of the purchase
price was presented on a preliminary basis at
September 30, 2008, due to the short time period
between the closing of the transaction (which
occurred simultaneously with its announcement on
September 25, 2008) and the end of the third
quarter. In accordance with SFAS 141, noncurrent
nonfinancial assets that are not held-for-sale,
such as the premises and equipment and other
intangibles, acquired in the Washington Mutual
transaction were written down against the negative
goodwill. The negative goodwill that remained after
writing down the nonfinancial assets was recognized
as an extraordinary gain. As a result of the
refinement of the purchase price allocation during
the fourth quarter of 2008, the initial
extraordinary gain of $581 million was increased
$1.3 billion to $1.9 billion. The computation of
the purchase price and the allocation of the
purchase price to the net assets acquired in the
Washington Mutual transaction – based upon their
respective values as of September 25, 2008, and the
resulting negative goodwill – are presented below.
The allocation of the purchase price may be
modified through September 25, 2009, as more
information is obtained about the fair value of
assets acquired and liabilities assumed.
Washington Mutual’s net assets before fair value adjustments
$
38,766
Washington Mutual’s goodwill and other intangible assets
(7,566
)
Subtotal
31,200
Adjustments to reflect assets acquired at fair value:
Securities
(20
)
Trading assets
(591
)
Loans
(31,018
)
Allowance for loan losses
8,216
Premises and equipment
680
Accrued interest and accounts receivable
(295
)
Other assets
4,125
Adjustments to reflect liabilities assumed at fair value:
Deposits
(683
)
Other borrowed funds
68
Accounts payable and other liabilities
(900
)
Long-term debt
1,127
Fair value of net assets acquired
11,909
Negative goodwill before allocation to nonfinancial assets
(9,968
)
Negative goodwill allocated to nonfinancial assets(a)
8,062
Negative goodwill resulting from the acquisition(b)
$
(1,906
)
(a)
The acquisition was accounted for as a purchase business combination in accordance with
SFAS 141. SFAS 141 requires the assets (including identifiable intangible assets) and liabilities
(including executory contracts and other commitments) of an acquired business as of the effective
date of the acquisition to be recorded at their respective fair values and consolidated with those
of JPMorgan Chase. The fair value of the net assets of Washington Mutual’s banking operations
exceeded the $1.9 billion purchase price, resulting in negative goodwill. In accordance with SFAS
141, noncurrent, nonfinancial assets not held-for-sale, such as premises and equipment and other
intangibles, were written down against the negative goodwill. The negative goodwill that remained
after writing down transaction related core deposit intangibles of approximately $4.9 billion and
premises and equipment of approximately $3.2 billion was recognized as an extraordinary gain of
$1.9 billion.
(b)
The extraordinary gain was recorded in Corporate/Private Equity.
The following condensed statement of net assets acquired reflects the value assigned to the
Washington Mutual net assets as of September 25, 2008.
Merger with The Bear Stearns Companies Inc.
Effective May 30, 2008, BSC Merger Corporation, a
wholly owned subsidiary of JPMorgan Chase, merged
with The Bear Stearns Companies Inc. (“Bear
Stearns”) pursuant to the Agreement and Plan of
Merger, dated as of March 16, 2008, as amended
March 24, 2008, and Bear Stearns became a wholly
owned subsidiary of JPMorgan Chase. The merger
provided the Firm with a leading global prime
brokerage platform; strengthened the Firm’s
equities and asset management businesses; enhanced
capabilities in mortgage origination,
securitization and servicing; and expanded the
platform of the Firm’s energy business. The merger
is being accounted for under the purchase method of
accounting, which requires that the assets and
liabilities of Bear Stearns be fair valued. The
total purchase price to
complete the merger was $1.5 billion.
The merger with Bear Stearns was accomplished
through a series of transactions that were
reflected as step acquisitions in accordance with
SFAS 141. On April 8, 2008, pursuant to the share
exchange agreement, JPMorgan Chase acquired 95
million newly issued shares of Bear Stearns common
stock (or 39.5% of Bear Stearns common stock after
giving effect to the issuance) for 21 million
shares of JPMorgan Chase common stock. Further,
between March 24, 2008, and May 12, 2008, JPMorgan
Chase acquired approximately 24 million shares of
Bear Stearns common stock in the open market at an
average purchase price of $12.37 per share. The
share exchange and cash purchase transactions
resulted in JPMorgan Chase owning approximately
49.4% of Bear Stearns common stock immediately
prior to consummation of the merger. Finally, on
May 30, 2008, JPMorgan Chase completed the merger.
As a result of the merger, each outstanding share
of Bear Stearns common stock (other than shares
then held by JPMorgan Chase) was converted into the
right to receive 0.21753 shares of common stock of
JPMorgan Chase. Also, on May 30, 2008, the shares
of common stock that JPMorgan Chase and Bear
Stearns acquired from each other in the share
exchange transaction were cancelled. From April 8,2008, through May 30, 2008, JPMorgan Chase
accounted for the investment in Bear Stearns under
the equity method of accounting in accordance with
APB 18. During this period, JPMorgan Chase recorded
reductions to its investment in Bear Stearns
representing its share of Bear Stearns net losses,
which was recorded in other income and accumulated
other comprehensive income.
In conjunction with the Bear Stearns merger, in
June 2008, the Federal Reserve Bank of New York
(the
“FRBNY”) took control, through a limited liability
company (“LLC”) formed for this purpose, of a
portfolio of $30 billion in assets acquired from
Bear Stearns, based on the value of the portfolio
as of March 14, 2008. The assets of the LLC were
funded by a $28.85 billion term loan from the
FRBNY, and a $1.15 billion subordinated loan from
JPMorgan Chase. The JPMorgan Chase note is
subordinated to the FRBNY loan and will bear the
first $1.15 billion of any losses of the portfolio.
Any remaining assets in the portfolio after
repayment of the FRBNY loan, the JPMorgan Chase
note and the expense of the LLC will be for the
account of the FRBNY.
As a result of step acquisition accounting,
the total $1.5 billion purchase price was allocated
to the Bear Stearns assets acquired and liabilities
assumed using their fair values as of April 8,2008, and May 30, 2008, respectively. The summary
computation of the purchase price and the
allocation of the purchase price to the net assets
of Bear Stearns are presented below. The allocation
of the purchase price may be modified through May30, 2009, as more information is obtained about the
fair value of assets acquired and liabilities
assumed.
(in millions, except for shares (in thousands), per share amounts and where otherwise noted)
Purchase price
Shares exchanged in the Share Exchange transaction (April 8, 2008)
95,000
Other Bear Stearns shares outstanding
145,759
Total Bear Stearns stock outstanding
240,759
Cancellation of shares issued in the Share Exchange transaction
(95,000
)
Cancellation of shares acquired by JPMorgan Chase for cash in the open market
(24,061
)
Bear Stearns common stock exchanged as of May 30, 2008
121,698
Exchange ratio
0.21753
JPMorgan Chase common stock issued
26,473
Average purchase price per JPMorgan Chase common share(a)
$
45.26
Total fair value of JPMorgan Chase common stock issued
$
1,198
Bear Stearns common stock acquired for cash in the open market (24 million
shares at an
average share price of $12.37 per share)
298
Fair value of employee stock awards (largely to be settled by shares held in
the RSU Trust(b))
242
Direct acquisition costs
27
Less: Fair value of Bear Stearns common stock held in the RSU Trust and
included in
the exchange of common stock
(269
)(b)
Total purchase price
1,496
Net assets acquired
Bear Stearns common stockholders’ equity
$
6,052
Adjustments to reflect assets acquired at fair value:
Trading assets
(3,831
)
Premises and equipment
497
Other assets
(235
)
Adjustments to reflect liabilities assumed at fair value:
Long-term debt
504
Other liabilities
(2,252
)
Fair value of net assets acquired excluding goodwill
735
Goodwill resulting from the merger(c)
$
761
(a)
The value of JPMorgan Chase common stock was determined by averaging the closing
prices of JPMorgan Chase’s common stock for the four trading days during the period March19, 2008, through March 25, 2008.
(b)
Represents shares of Bear Stearns common stock held in an irrevocable grantor
trust (the “RSU Trust”) to be used to settle stock awards granted to selected employees
and certain key executives under certain heritage Bear Stearns employee stock plans.
Shares in the RSU Trust were exchanged for 6 million shares of JPMorgan Chase common stock
at the merger exchange ratio of 0.21753. For further discussion of the RSU trust, see Note
10 on pages 155–158 of this Annual Report.
Federal funds purchased and securities loaned or sold
under repurchase agreements
$
54,643
Other borrowings
16,166
Trading liabilities
24,267
Beneficial interests issued by consolidated VIEs
47,042
Long-term debt
67,015
Accounts payable and other liabilities
78,532
Total liabilities
287,665
Bear Stearns net assets(a)
$
1,066
(a)
Reflects the fair value assigned to 49.4% of the Bear Stearns net assets acquired
on April 8, 2008 (net of related amortization), and the fair value assigned to the
remaining 50.6% of the Bear Stearns net assets acquired on May 30, 2008. The difference
between the Bear Stearns net assets acquired as presented above and the fair value of the
net assets acquired (including goodwill) presented in the previous table represents
JPMorgan Chase’s net losses recorded under the equity method of accounting.
Unaudited pro forma condensed combined
financial information reflecting Bear Stearns
merger and Washington Mutual transaction
The following unaudited pro forma condensed
combined financial information presents the results
of operations of the Firm as they may have appeared
if the Bear Stearns merger and the Washington
Mutual transaction had been completed on January 1,2008, and January 1, 2007.
Year ended December 31,
(in millions, except per share data)
2008
2007
Total net revenue
$
68,071
$
92,052
Income (loss) before extraordinary gain
(14,141
)
17,733
Net income (loss)
(12,235
)
17,733
Net income per common share data:
Basic earnings per share
Income (loss) before extraordinary gain
$
(4.22
)
$
5.16
Net income (loss)
(3.68
)
5.16
Diluted earnings per share(a)
Income (loss) before extraordinary gain
(4.22
)
5.01
Net income (loss)
(3.68
)
5.01
Average common shares issued and outstanding
Basic
3,511
3,430
Diluted(a)
3,511
3,534
(a)
Common equivalent shares have been excluded from the pro forma computation of
diluted loss per share for the year ended December 31, 2008, as the effect would be
antidilutive.
The unaudited pro forma combined financial
information is presented for illustrative purposes
only and does not indicate the financial results of
the combined company had the companies actually
been combined as of January 1, 2008, or as of
January 1, 2007, nor is it indicative of the
results of operations in future periods. Included
in the unaudited pro forma combined financial
information for the years ended December 31, 2008
and 2007, were pro forma adjustments to reflect the
results of operations of Bear Stearns, and
Washington Mutual’s banking operations, considering
the purchase accounting, valuation and accounting
conformity adjustments related to each transaction.
For the Washington Mutual transaction, the
amortization of purchase accounting adjustments to
report interest-earnings assets acquired and
interest-bearing liabilities assumed at current
interest rates is reflected in all periods
presented. Valuation adjustments and the adjustment
to conform allowance methodologies in the
Washington Mutual transaction, and valuation and
accounting conformity adjustments related to the
Bear Stearns merger are reflected in the results
for the years ended December 31, 2008 and 2007.
Internal reorganization related to the Bear Stearns merger
On June 30, 2008, JPMorgan Chase fully and
unconditionally guaranteed each series of
outstanding preferred stock of Bear Stearns, as
well as all of Bear Stearns’ outstanding Securities
and Exchange Commission (“SEC”) registered U.S.
debt securities and obligations relating to trust
preferred capital debt securities. Subsequently, on
July 15, 2008, JPMorgan Chase completed an internal
merger transaction, which resulted in each series
of outstanding preferred stock of Bear Stearns
being automatically exchanged into newly issued
shares of JPMorgan Chase preferred stock having
substantially identical terms. Depositary shares,
which formerly had represented a one-fourth
interest in a share of Bear Stearns preferred
stock, continue to trade on the New York Stock
Exchange but following completion of this internal
merger transaction, represent a one-fourth interest
in a share of JPMorgan Chase preferred stock. In
addition, on July 31, 2008, JPMorgan Chase assumed
(1) all of Bear Stearns’ then-outstanding
SEC-registered U.S. debt securities; (2) Bear
Stearns’ obligations relating to trust preferred
capital debt securities; (3) certain of Bear
Stearns’ then-outstanding foreign debt securities;
and (4) certain of Bear Stearns’ guarantees of
then-outstanding foreign debt securities issued by
subsidiaries of Bear Stearns, in each case, in
accordance with the agreements and indentures
governing these securities. JPMorgan Chase also
guaranteed Bear Stearns’ obligations under Bear Stearns’ U.S. $30.0 billion Euro Medium Term Note
Programme and U.S. $4.0 billion Euro Note Issuance
Programme.
Other business events
Termination of Chase Paymentech Solutions joint venture
The dissolution of Chase Paymentech Solutions joint
venture, a global payments and merchant acquiring
joint venture between JPMorgan Chase and First Data
Corporation, was completed on November 1, 2008.
JPMorgan Chase retained approximately 51% of the
business and will operate the business under the
name Chase Paymentech Solutions. The dissolution of
Chase Paymentech
Solutions joint venture was accounted for as a
step acquisition in accordance with SFAS 141, and
the Firm recognized an after-tax gain of $627
million in the fourth quarter of 2008 as a result
of the dissolution. The gain represents the amount
by which the fair value of the net assets acquired
(predominantly intangible assets and goodwill)
exceeded JPMorgan Chase’s book basis in the net
assets transferred to First Data Corporation. Upon
dissolution, the Firm began to consolidate the
retained Chase Paymentech Solutions business.
Proceeds from Visa Inc. shares
On March 19, 2008, Visa Inc. (“Visa”) completed
its initial public offering (“IPO”). Prior to the
IPO, JPMorgan Chase held approximately a 13%
equity interest in Visa. On March 28, 2008, Visa
used a portion of the proceeds from the offering
to redeem a portion of the Firm’s equity interest,
which resulted in the recognition of a pre-tax
gain of $1.5 billion (recorded in other income).
In conjunction with the IPO, Visa placed $3.0
billion in escrow to cover liabilities related to
certain litigation matters. The escrow was
increased by $1.1 billion in the fourth quarter of 2008.
JPMorgan Chase’s interest in the escrow was
recorded as a reduction of other expense and
reported net to the extent of established
litigation reserves.
Purchase of additional interest in Highbridge
Capital Management
In January 2008, JPMorgan Chase purchased an
additional equity interest in Highbridge Capital
Management, LLC (“Highbridge”). As a result, the
Firm currently owns 77.5% of Highbridge.
Acquisition of the consumer, business banking and
middle-market banking businesses of The Bank of
New York in exchange for selected corporate trust
businesses, including trustee, paying agent, loan
agency and document management services
On October 1, 2006, JPMorgan Chase completed the
acquisition of The Bank of New York Company, Inc.’s
(“The Bank of New York”) consumer, business and
middle-market banking businesses in exchange for
selected corporate trust businesses plus a cash
payment of $150 million. The transaction also included a
contingent payment payable to The Bank of New York;
the amount due of $25 million was paid in 2008. The
acquisition added 339 branches and more than 400
ATMs, and it significantly strengthened Retail
Financial Services’ distribution network in the New
York tri-state area. The Bank of New York
businesses acquired were valued at a premium of
$2.3 billion; the Firm’s corporate trust businesses
that were transferred (i.e., trustee, paying agent,
loan agency and document management services) were
valued at a premium of $2.2 billion. This
transaction included the acquisition of
approximately $7.7 billion in loans net of
allowance for loan losses and $12.9 billion in
deposits from the Bank of New York. The Firm also
recognized core deposit intangibles of $485
million, which are being amortized using an
accelerated method over a 10-year period. JPMorgan
Chase recorded an after-tax gain of $622 million on
this transaction in the fourth quarter of 2006. For
additional discussion related to the transaction,
see Note 3 on pages 128–129 of this Annual Report.
JPMorgan Partners management
On August 1, 2006, the buyout and growth equity
professionals of JPMorgan Partners (“JPMP”) formed
an independent firm, CCMP Capital, LLC (“CCMP”),
and the venture professionals separately formed an
independent firm, Panorama Capital, LLC
(“Panorama”). The investment professionals of CCMP
and Panorama continue to manage the former JPMP
investments pursuant to a management agreement
with the Firm.
Sale of insurance underwriting business
On July 1, 2006, JPMorgan Chase completed the sale
of its life insurance and annuity underwriting
businesses to Protective Life Corporation for cash
proceeds of approximately $1.2 billion, consisting
of $900 million of cash received from Protective
Life Corporation and approximately $300 million of
preclosing dividends received from the entities
sold. The after-tax impact of this transaction was
negligible. The sale included both the heritage
Chase insurance business and the insurance business
that Bank One had bought from Zurich Insurance in
2003.
Acquisition of private-label credit card portfolio
from Kohl’s Corporation
On April 21, 2006, JPMorgan Chase completed the acquisition of
$1.6 billion of private-label credit card
receivables and approximately 21 million accounts
from Kohl’s Corporation (“Kohl’s”). JPMorgan Chase
and Kohl’s also entered into an agreement under
which JPMorgan Chase is offering private-label
credit cards to both new and existing Kohl’s
customers.
Collegiate Funding Services
On March 1, 2006, JPMorgan Chase acquired, for
approximately $663 million, Collegiate Funding
Services, a leader in student loan servicing and
consolidation. This acquisition included $6
billion of student loans.
Note 3
– Discontinued operations
On October 1, 2006, JPMorgan Chase completed
the acquisition of The Bank of New York’s consumer,
small-business and middle-market banking businesses
in exchange for selected corporate trust
businesses. Refer to Note 2 on pages 123–128 of
this Annual Report for additional information.
In anticipation of the close of the transaction on
October 1, 2006, effective with the second quarter
of 2006, the results of operations of these
corporate trust businesses were transferred from
the Treasury & Securities Services (“TSS”) segment
to the Corporate/Private Equity segment, and
reported as discontinued operations. Condensed
financial information of the selected corporate
trust businesses follows.
There was no income from discontinued operations during 2008 or 2007.
The following is a summary of the assets and
liabilities associated with the selected
corporate trust businesses related to the Bank of
New York transaction that closed on October 1,2006.
JPMorgan Chase provides certain transitional
services to The Bank of New York for a defined
period of time after the closing date. The Bank of
New York compensates JPMorgan Chase for these
transitional services.
Note 4
– Fair value measurement
In September 2006, the FASB issued SFAS 157 (“Fair Value Measurements”), which was effective for fiscal
years beginning after November 15, 2007, with early
adoption permitted. The Firm chose early adoption
for SFAS 157 effective January 1, 2007. SFAS 157:
•
Defines fair value as the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants at the
measurement date, and establishes a framework for measuring fair value;
•
Establishes a three-level hierarchy for fair value measurements based upon the
transparency of inputs to the valuation of an asset or liability as of the measurement
date;
•
Nullifies the guidance in EITF 02-3, which required the deferral of profit at
inception of a transaction involving a derivative financial instrument in the absence of
observable data supporting the valuation technique;
•
Eliminates large position discounts for financial instruments quoted in active
markets and requires consideration of the Firm’s creditworthiness when valuing
liabilities; and
•
Expands disclosures about instruments measured at fair value.
The Firm also chose early adoption for SFAS 159
effective January 1, 2007. SFAS 159 provides an
option to elect fair value as an alternative
measurement for selected financial assets,
financial liabilities, unrecognized firm
commitments and written loan commitments not
previously recorded at fair value. The Firm elected
fair value accounting for certain assets and
liabilities not previously carried at fair value.
For more information, see Note 5 on pages 144–146
of this Annual Report.
The following is a description of the Firm’s
valuation methodologies for assets and liabilities
measured at fair value.
The Firm has an established and well-documented
process for determining fair values. Fair value is
based upon quoted market prices, where available.
If listed prices or quotes are not available, fair
value is based upon internally developed models
that primarily use, as inputs, market-based or
independently sourced market parameters, including
but not limited to yield curves, interest rates,
volatilities, equity or debt prices, foreign
exchange rates and credit curves. In addition to
market information, models also incorporate
transaction details, such as maturity of the
instrument. Valuation adjustments may be made to
ensure that financial instruments are recorded at
fair value. These adjustments include amounts to
reflect counterparty credit quality, the Firm’s
creditworthiness, constraints on liquidity and
unobservable parameters. Valuation adjustments are
applied consistently over time.
•
Credit valuation adjustments (“CVA”) are necessary when the market price (or
parameter) is not indicative of the credit quality of the counterparty. As few classes of
derivative contracts are listed on an exchange, the majority of derivative positions are
valued using internally developed models that use as their basis observable market
parameters. Market practice is to quote parameters equivalent to a “AA” credit rating
whereby all counterparties are assumed to have the same credit quality. Therefore, an
adjustment is necessary to reflect the credit quality of each derivative counterparty to
arrive at fair value. The adjustment also takes into account contractual factors designed
to reduce the Firm’s credit exposure to each counterparty, such as collateral and legal
rights of offset.
•
Debit valuation adjustments (“DVA”) are necessary to reflect the credit quality of
the Firm in the valuation of liabilities measured at fair value. This adjustment was
incorporated into the Firm’s valuations commencing January 1, 2007, in accordance with
SFAS 157. The methodology to determine the adjustment is consistent with CVA and
incorporates JPMorgan Chase’s credit spread as observed through the credit default swap
market.
•
Liquidity valuation adjustments are necessary when the Firm may not be able to
observe a recent market price for a financial instrument that trades in inactive (or less
active) markets or to reflect the cost of exiting larger-than-normal market-size risk
positions (liquidity adjustments are not taken for positions classified within level 1 of
the fair value hierarchy). The Firm tries to ascertain the amount of uncertainty in the
initial valuation based upon the degree of liquidity of the market in which the financial
instrument trades and makes liquidity adjustments to the carrying value of the
financial instrument. The Firm measures the liquidity adjustment based upon the following
factors: (1) the amount of time since the last relevant pricing point; (2) whether there
was an actual trade or relevant external quote; and (3) the volatility of the principal
risk component of the financial instrument. Costs to exit larger-than-normal market-size
risk positions are determined based upon the size of the adverse market move that is likely
to occur during the period required to bring a position down to a nonconcentrated level.
•
Unobservable parameter valuation adjustments are necessary when positions are valued
using internally developed models that use as their basis
unobservable parameters – that
is, parameters that must be estimated and are, therefore, subject to management judgment.
These positions are normally traded less actively. Examples include certain credit products where parameters such as correlation and recovery
rates are unobservable. Unobservable parameter valuation adjustments are applied to
mitigate the possibility of error and revision in the estimate of the market price provided
by the model.
The Firm has numerous controls in place intended to
ensure that its fair valuations are appropriate. An
independent model review group reviews the Firm’s
valuation models and approves them for use for
specific products. All valuation models within the
Firm are subject to this review process. A price
verification group, independent from the
risk-taking function, ensures observable market
prices and market-based parameters are used for
valuation wherever possible. For those products
with material parameter risk for which observable
market levels do not exist, an independent review
of the assumptions made on pricing is performed.
Additional review includes deconstruction of the
model valuations for certain structured instruments
into their components, and benchmarking valuations,
where possible, to similar products; validating
valuation estimates through actual cash settlement;
and detailed review and explanation of recorded
gains and losses, which are analyzed daily and over
time. Valuation adjustments, which are also
determined by the independent price verification
group, are based upon established policies and are
applied consistently over time. Any changes to the
valuation methodology are reviewed by management to
confirm the changes are justified. As markets and
products develop and the pricing for certain
products becomes more or less transparent, the Firm
continues to refine its valuation methodologies. During 2008, no material changes
were made to the Firm’s valuation models.
The methods described above to estimate fair value
may produce a fair value calculation that may not
be indicative of net realizable value or reflective
of future fair values. Furthermore, while the Firm
believes its valuation methods are appropriate and
consistent with other market participants, the use
of different methodologies or assumptions to
determine the fair value of certain financial
instruments could result in a different estimate of
fair value at the reporting date.
Valuation Hierarchy
SFAS 157 establishes a three-level valuation
hierarchy for disclosure of fair value
measurements. The valuation hierarchy is based
upon the transparency of inputs to the valuation
of an asset or liability as
of the measurement date. The three levels are defined as follows.
•
Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for
identical assets or liabilities in active markets.
•
Level 2 – inputs to the valuation methodology include quoted prices for similar
assets and liabilities in active markets, and inputs that are observable for the asset or
liability, either directly or indirectly, for substantially the full term of the financial
instrument.
•
Level 3 – inputs to the valuation methodology are unobservable and significant to
the fair value measurement. For a level 3 analysis, see pages 138–139 of this Note.
A financial instrument’s categorization within the
valuation hierarchy is based upon the lowest level
of input that is significant to the fair value
measurement.
Following is a description of the valuation
methodologies used for instruments measured at
fair value, including the general classification
of such instruments pursuant to the valuation
hierarchy.
Assets
Securities purchased under resale agreements
(“resale agreements”)
To estimate the fair value of resale agreements,
cash flows are evaluated taking into consideration
any derivative features of the resale agreement and
are then discounted using the appropriate market
rates for the applicable maturity. As the inputs
into the valuation are primarily based upon readily
observable pricing information, such resale
agreements are generally classified within level 2
of the valuation hierarchy.
Loans and unfunded lending-related commitments
The majority of the Firm’s loans and
lending-related commitments are not carried at fair
value on a recurring basis on the Consolidated
Balance Sheets, nor are they actively traded. The
fair value of such loans and lending-related
commitments is included in the disclosures required
by SFAS 107 on pages 142–143 of this Note. Loans
carried at fair value on a recurring and
nonrecurring basis are included in the applicable
tables that follow.
Wholesale
The fair value of loans and lending-related
commitments is calculated using observable market
information, including pricing from actual market
transactions or broker quotations where available.
Where pricing information is not available for the
specific loan, the valuation is generally based
upon quoted market prices of similar instruments,
such as loans and bonds. These comparable
instruments share characteristics that typically
include industry, rating, capital structure,
seniority, and consideration of counterparty credit
risk. In addition, general market conditions,
including prevailing market spreads for credit and
liquidity risk, are also considered in the
valuation process.
For certain loans that are expected to be
securitized, such as commercial and residential
mortgages, fair value is estimated based upon
observable pricing of asset-backed securities
(“ABS”) with similar
collateral and incorporates adjustments (i.e.,
reductions) to these prices to account for
securitization uncertainties including portfolio
composition, market conditions and liquidity to
arrive at the whole loan price. When data from
recent market transactions is available it is
incorporated as appropriate. If particular loans
are not expected to be securitized they are marked
for individual sale taking into consideration
potential liquidation proceeds and property
repossession/liquidation information, as
appropriate. For further discussion of the
valuation of mortgage loans carried at fair value,
see the “Mortgage-related exposures carried at fair
value” section of this Note on pages 139–141.
The Firm’s loans carried at fair value and reported
in trading assets are largely classified within
level 3 due to the lack of observable pricing.
Loans carried at fair value and reported in loans
including leveraged lending funded loans,
high-yield bridge financing and purchased
non-performing loans held in the Investment Bank
(“IB”) are classified within level 2 or 3 of the
valuation hierarchy depending on the level of
liquidity and activity in the markets for a
particular product.
Consumer
Fair values for consumer installment loans
(including automobile financings and consumer real
estate not expected to be securitized), for which
market rates for comparable loans are readily
available, are based upon discounted cash flows
adjusted for prepayment assumptions. The discount
rates used for consumer installment loans are based
on current market rates for new originations of
comparable loans. Fair value for credit card
receivables is based upon discounted expected cash
flows. The discount rates used for credit card
receivables incorporate only the effects of
interest rate changes, since the expected cash
flows already reflect an adjustment for credit
risk. Consumer installment loans and credit card
receivables that are not carried on the balance sheet at
fair value are not classified
within the fair value hierarchy. For further discussion of the
valuation of mortgage loans carried at fair value, see the
“Mortgage-related exposures carried at fair value” section of
this Note.
Securities
Where quoted prices for identical securities are
available in an active market, securities are
classified in level 1 of the valuation hierarchy.
Level 1 securities include highly liquid government
bonds, mortgage products for which there are quoted
prices in active markets (such as U.S. government
agency or U.S. government-sponsored enterprise
pass-through mortgage-backed securities) and
exchange-traded equities.
If quoted market prices are not available for the
specific security, the Firm may estimate the value
of such instruments using a combination of observed
transaction prices, independent pricing services
and relevant broker quotes. Consideration is given
to the nature of the quotes (e.g., indicative or
firm) and the relationship of recently evidenced
market activity to the prices provided from
independent pricing services. The Firm may also use
pricing models or discounted cash flows. In cases
where there is limited activity or less
transparency around inputs to the valuation,
securities are classified within level 3 of the
valuation hierarchy.
For certain collateralized mortgage and debt
obligations, asset-backed securities and high-yield
debt securities the determination of fair value may
require benchmarking to similar instruments or
analyzing
default and recovery rates. For “cash”
collateralized debt obligations (“CDOs”), external
price information is not available. Therefore, cash
CDOs are valued using market-standard models, such
as Intex, to model the specific collateral
composition and cash flow structure of each deal;
key inputs to the model are market spread data for
each credit rating, collateral type and other
relevant contractual features. Asset-backed
securities are valued based on external prices or
market spread data, using current market
assumptions on prepayments and defaults. For those
asset-backed securities where the external price
data is not observable or the limited available
data is opaque, the collateral performance is
monitored and the value of the security is
assessed. To benchmark its valuations, the Firm
looks to transactions for similar instruments and
utilizes independent pricing provided by
third-party vendors, broker quotes and relevant
market indices such as the ABX index, as
applicable. While none of those sources are solely
indicative of fair value, they serve as directional
indicators for the appropriateness of the Firm’s
estimates. The majority of collateralized mortgage
and debt obligations, high-yield debt securities
and asset-backed securities are currently
classified in level 3 of the valuation hierarchy.
For further discussion of the valuation of mortgage
securities carried at fair value see the “Mortgage-related exposures carried at fair value” section of
this Note on pages 139–141.
Commodities
Commodities inventory is carried at the lower of
cost or fair value. The fair value for commodities
inventory is determined primarily using pricing and
data derived from the markets on which the
underlying commodities are traded. Market prices
may be adjusted for liquidity. The Firm also has
positions in commodity-based derivatives that can be traded on an exchange or
over-the-counter. The pricing inputs to these
derivatives include forward curves of underlying
commodities, basis curves, volatilities,
correlations, and occasionally other model
parameters. The valuation of these derivatives is
based upon calibrating to market transactions, as
well as to independent pricing information from
sources such as brokers and dealer consensus
pricing services. Where inputs are unobservable,
they are benchmarked to observable market data
based upon historic and implied correlations, then
adjusted for uncertainty where appropriate. The
majority of commodities inventory and
commodities-based derivatives are classified within
level 2 of the valuation hierarchy.
Derivatives
Exchange-traded derivatives valued using quoted
prices are classified within level 1 of the
valuation hierarchy. However, few classes of
derivative contracts are listed on an exchange;
thus, the majority of the Firm’s derivative
positions are valued using internally developed
models that use as their basis readily observable
market parameters – that is, parameters that are
actively quoted and can be validated to external
sources, including industry pricing services.
Depending on the types and contractual terms of
derivatives, fair value can be modeled using a
series of techniques, such as the Black-Scholes
option pricing model, simulation models or a
combination of various models, which are
consistently applied. Where derivative products
have been established for some time, the Firm uses
models that are widely accepted in the financial
services industry. These models reflect the
contractual terms of the derivatives, including
the period to maturity, and market-based parameters
such as interest rates, volatility, and the credit
quality of the counterparty. Further, many of these
models do not contain a high level of subjectivity,
as the methodologies used in the models do not
require significant judgment, and inputs to the
model are readily observable from actively quoted
markets, as is the case for “plain vanilla”
interest rate swaps and option contracts and credit
default swaps (“CDS”). Such instruments are
generally classified within level 2 of the
valuation hierarchy.
Derivatives that are valued based upon models with
significant unobservable market parameters and that
are normally traded less actively, have trade
activity that is one way, and/or are traded in
less-developed markets are classified within level
3 of the valuation hierarchy. Level 3 derivatives,
for example, include credit default swaps
referenced to mortgage-backed securities, certain
types of CDO transactions, options on baskets of
single-name stocks, and callable exotic interest
rate options. Such derivatives are primarily used for risk management purposes.
For certain derivative products, such as credit
default swaps referenced to mortgage-backed
securities, the value is based on the underlying
mortgage risk. As these instruments are not actively quoted, the estimate
of fair value considers the valuation of the
underlying collateral (mortgage loans). Inputs to
the valuation will include available information on
similar underlying loans or securities in the cash
market. The prepayments and loss assumptions on the
underlying loans or securities are estimated using a
combination of historical data, prices on market
transactions, and other prepayment and default
scenarios and analysis. Relevant observable market
indices such as the ABX or CMBX, are considered,
as well as any relevant transaction activity.
Other complex products, such as those sensitive to
correlation between two or more underlyings, also
fall within level 3 of the hierarchy. Such
instruments include complex credit derivative
products which are illiquid and non-standard in
nature, including CDOs and CDO-squared. A CDO is a
debt security collateralized by a variety of debt
obligations, including bonds and loans of different
maturities and credit qualities. The repackaging of
such securities and loans within a CDO results in the creation of
tranches, which are instruments with differing risk profiles. In a
CDO-squared, the instrument is a CDO where the
underlying debt instruments are also CDOs. For
CDO-squared transactions, while inputs such as CDS
spreads and recovery rates may be observable, the
correlation between the underlying debt instruments
is unobservable. The correlation levels are not
only modeled on a portfolio basis but are also
calibrated at a transaction level to liquid
benchmark tranches. For all complex credit
derivative products, actual transactions, where
available, are used to regularly recalibrate all
unobservable parameters.
Correlation sensitivity is also material to the
overall valuation of options on baskets of
single-name stocks; the valuation of these baskets
is typically not observable due to their
non-standardized structuring. Correlation for
products such as these are typically estimated
based on an observable basket of stocks and then
adjusted to reflect the differences between the
underlying equities.
For callable exotic interest rate options, while
most of the assumptions in the valuation can be
observed in active markets (e.g. interest rates and
volatility), the callable option transaction flow
is essentially one-way, and as such, price
observability is limited. As pricing information is
limited, assumptions are based upon the dynamics of
the underlying markets (e.g. the interest rate
markets) including the range and possible outcomes
of the applicable inputs. In addition, the models
used are calibrated, as relevant, to liquid
benchmarks and valuation is tested against monthly
independent pricing services and actual
transactions.
Mortgage servicing rights and certain retained
interests in securitizations
Mortgage servicing rights (“MSRs”) and certain
retained interests from securitization activities
do not trade in an active, open market with readily
observable prices. While sales of MSRs do occur,
the precise terms and conditions typically are not
readily available. Accordingly, the Firm estimates the fair value of
MSRs and certain other retained interests in
securitizations using discounted cash flow (“DCF”)
models.
•
For MSRs, the Firm uses an option-adjusted spread (“OAS”) valuation model in
conjunction with the Firm’s proprietary prepayment model to project MSR cash flows over
multiple interest rate scenarios, which are then discounted at risk-adjusted rates to
estimate an expected fair value of the MSRs. The OAS model considers portfolio
characteristics, contractually specified servicing fees, prepayment assumptions,
delinquency rates, late charges, other ancillary revenue, costs to service and other
economic factors. The Firm reassesses and periodically adjusts the underlying inputs and
assumptions used in the OAS model to reflect market conditions and assumptions that a
market participant would consider in valuing the MSR asset. Due to the nature of the
valuation inputs, MSRs are classified within level 3 of the valuation hierarchy.
•
For certain retained interests in securitizations (such as interest-only strips), a
single interest rate path discounted cash flow model is used and generally includes
assumptions based upon projected finance charges related to the securitized assets,
estimated net credit losses, prepayment assumptions and contractual interest paid to
third-party investors. Changes in the assumptions used may have a significant impact on
the Firm’s valuation of retained interests, and such interests are therefore typically
classified within level 3 of the valuation hierarchy.
For both MSRs and certain other retained interests
in securitizations, the Firm compares its fair
value estimates and assumptions to observable
market data where available and to recent market
activity and actual portfolio experience. For
further discussion of the most significant
assumptions used to value retained interests
in securitizations and MSRs, as well as the
applicable stress tests for those assumptions, see
Note 16 and Note 18 on pages 168–176 and 186–189,
respectively, of this Annual Report.
Private equity investments
The valuation of nonpublic private equity
investments, held primarily by the Private Equity
business within Corporate, requires significant
management judgment due to the absence of quoted
market prices, the inherent lack of liquidity and
the long-term nature of such assets. As such,
private equity investments are valued initially
based upon cost. Each quarter, valuations are
reviewed utilizing available and relevant market
data to determine if the carrying value of these
investments should be adjusted. Such market data
primarily includes observations of the trading
multiples of public companies considered comparable
to the private companies being valued and the
operating performance of the underlying portfolio
company, including its historical and projected net
income and earnings before interest, taxes,
depreciation and amortization (“EBITDA”).
Valuations are adjusted to account for
company-specific issues, the lack of liquidity
inherent in a nonpublic investment and the fact
that comparable public companies are not identical
to the companies being valued. In addition, a variety
of additional factors are reviewed by management,
including, but not limited to, financing and sales transactions with third parties, future
expectations of the particular investment, changes
in market outlook and the third-party financing
environment. The Firm applies its valuation
methodology consistently from period to period and
believes that the methodology and associated
valuation adjustments are appropriate. Nonpublic
private equity investments are included in level 3
of the valuation hierarchy.
Private equity investments also include publicly
held equity investments, generally obtained through
the initial public offering of privately held
equity investments. Publicly held investments in
liquid markets are marked to market at the quoted
public value less adjustments for regulatory or
contractual sales restrictions. Discounts for
restrictions are quantified by analyzing the length
of the restriction period and the volatility of the
equity security. Publicly held investments are
largely classified in level 2 of the valuation
hierarchy.
Other assets
The fair value of asset-backed commercial paper
(“ABCP”) investments purchased under the Federal
Reserve’s Asset-Backed Commercial Paper Money
Market Mutual Fund Liquidity Facility (“AML
Facility”) for U.S. money market mutual funds is
determined based on observable market information and is classified in level 2 of the
valuation hierarchy.
Liabilities
Securities sold under repurchase agreements
(“repurchase agreements”)
To estimate the fair value of repurchase
agreements, cash flows are evaluated taking into
consideration any derivative features and are then
discounted using the appropriate market rates for
the applicable maturity. Generally, for these types of agreements,
there is a requirement that collateral be maintained with a market
value equal to, or in excess of, the principal amount loaned; as a
result, there would be no adjustment, or an immaterial adjustment,
to reflect the credit quality of the Firm (i.e., DVA) related to these agreements. As the inputs into the
valuation are primarily based upon observable
pricing information, repurchase agreements are
classified within level 2 of the valuation
hierarchy.
Beneficial interests issued by consolidated VIEs
The fair value of beneficial interests issued by
consolidated VIEs (“beneficial interests”) is
estimated based upon the fair value of the
underlying assets held by the VIEs. The valuation
of beneficial interests does not include an
adjustment to reflect the credit quality of the
Firm, as the holders of these beneficial interests
do not have recourse to the general credit of
JPMorgan Chase. As the inputs into the valuation
are generally based upon readily observable market
pricing information, the majority of beneficial
interests issued by consolidated VIEs are
classified within level 2 of the valuation
hierarchy.
Deposits, other borrowed funds and long-term debt
Included within deposits, other borrowed funds and
long-term debt are structured notes issued by the
Firm that are financial instruments containing
embedded derivatives. To estimate the fair value of
structured notes, cash flows are evaluated taking
into consideration any derivative features and are
then discounted using the appropriate market rates
for the applicable maturities. In addition, the
valuation of structured notes includes an adjustment to reflect the credit
quality of the Firm (i.e., the DVA). Where the
inputs into the valuation are primarily based upon
readily observable market pricing information, the
structured notes are classified within level 2 of
the valuation hierarchy. Where significant inputs
are unobservable, structured notes are classified
within level 3 of the valuation hierarchy.
The following table presents the financial instruments carried at fair value as of December 31,2008 and 2007, by caption on the Consolidated Balance Sheets and by SFAS 157 valuation hierarchy
(as described above).
Assets and liabilities measured at fair value on a recurring basis
Federal
funds sold and securities purchased under resale agreements
$
—
$
19,131
$
—
$
—
$
19,131
Trading assets:
Debt and equity instruments:
U.S. government, agency, sponsored
enterprise and non-U.S. governments
106,572
40,362
258
—
147,192
State and municipal securities
7,230
5,860
—
—
13,090
Certificates of deposit, bankers’
acceptances and commercial paper
3,019
5,233
—
—
8,252
Corporate debt and other
6
52,137
7,972
—
60,115
Equity securities
82,499
9,552
1,197
—
93,248
Loans
—
46,038
11,776
—
57,814
Mortgage- and asset-backed securities
—
27,209
2,863
—
30,072
Physical commodities(a)
—
4,490
—
—
4,490
Total debt and equity instruments:
199,326
190,881
24,066
—
414,273
Derivative receivables
18,574
871,105
20,188
(832,731
)
77,136
Total trading assets
217,900
1,061,986
44,254
(832,731
)
491,409
Available-for-sale securities
71,941
13,364
101
—
85,406
Loans
—
359
8,380
—
8,739
Mortgage servicing rights
—
—
8,632
—
8,632
Other assets:
Private equity investments
68
322
6,763
—
7,153
All other
10,784
1,054
3,160
—
14,998
Total other assets
10,852
1,376
9,923
—
22,151
Total assets at fair value
$
300,693
$
1,096,216
$
71,290
$
(832,731
)
$
635,468
Deposits
$
—
$
5,228
$
1,161
$
—
$
6,389
Federal funds purchased and
securities
loaned or sold under repurchase
agreements
—
5,768
—
—
5,768
Other borrowed funds
—
10,672
105
—
10,777
Trading liabilities:
Debt and equity instruments
73,023
15,659
480
—
89,162
Derivative payables
19,553
852,055
19,555
(822,458
)
68,705
Total trading liabilities
92,576
867,714
20,035
(822,458
)
157,867
Accounts payable and
other liabilities(c)
—
—
25
—
25
Beneficial interests issued by
consolidated VIEs
—
2,922
82
—
3,004
Long-term debt
—
48,518
21,938
—
70,456
Total liabilities at fair value
$
92,576
$
940,822
$
43,346
$
(822,458
)
$
254,286
(a)
Physical commodities inventories are accounted for at the lower of cost or fair
value.
(b)
Includes assets for which the Firm serves as an intermediary between two parties
and does not bear market risk. The assets are predominantly reflected within derivative
receivables.
(c)
Includes the fair value adjustment for unfunded lending-related commitments
accounted for at fair value.
(d)
As permitted under FIN 39, the Firm has elected to net derivative receivables and
derivative payables and the related cash collateral received and paid when a legally
enforceable master netting agreement exists. The increase in FIN 39 netting from December31, 2007, primarily relates to the decline in interest rates, widening credit spreads and
volatile foreign exchange rates reflected in interest rate, credit and foreign exchange
derivatives, respectively.
Balances for which the Firm did not bear economic exposure at December 31, 2007, were not
significant.
Changes in level 3 recurring fair value measurements
The tables below include a rollforward of the
balance sheet amounts for the years ended December31, 2008 and 2007 (including the change in fair
value), for financial instruments classified by the
Firm within level 3 of the valuation hierarchy.
When a determination is made to classify a
financial instrument within level 3, the
determination is based upon the significance of the
unobservable parameters to the overall fair value
measurement. However, level 3 financial instruments
typically include, in addition to the unobservable
or level 3 components, observable components (that
is, components that are
actively quoted and can be validated to external
sources); accordingly, the gains and losses in the
table below include changes in fair value due in
part to observable factors that are part of the
valuation methodology. Also, the Firm risk manages
the observable components of level 3 financial
instruments using securities and derivative
positions that are classified within level 1 or 2
of the valuation hierarchy; as these level 1 and
level 2 risk management instruments are not
included below, the gains or losses in the tables
do not reflect the effect of the Firm’s risk
management activities related to such level 3
instruments.
Fair value measurements using significant unobservable inputs
Private equity instruments represent investments within the Corporate/Private
Equity line of business.
(b)
Level 3 liabilities as a percentage of total Firm liabilities accounted for at
fair value (including liabilities carried at fair value on a nonrecurring basis) were 25%
and 17% at December 31, 2008 and 2007, respectively. The Firm does not allocate the FIN 39
netting adjustment across the levels of the fair value hierarchy. As such, the level 3
derivative payables balance included in the level 3 total balance is
gross of any netting adjustments.
(c)
Beginning January 1, 2008, all transfers in and out of level 3 are assumed to
occur at the beginning of the reporting period.
(d)
Reported in principal transactions revenue.
(e)
Changes in fair value for Retail Financial Services mortgage loans originated with
the intent to sell and MSRs are measured at fair value and reported in mortgage fees and
related income.
(f)
Realized gains (losses) are reported in securities gains (losses). Unrealized
gains (losses) are reported in accumulated other comprehensive income (loss).
Assets and liabilities measured at
fair value on a nonrecurring basis
Certain assets, liabilities and unfunded
lending-related commitments are measured at fair
value on a nonrecurring basis; that is, the
instruments are not measured at fair value on an
ongoing basis but are subject to fair value
adjustments only in certain circumstances
(for example, when there is evidence of
impairment). The following tables present the
financial instruments carried on the Consolidated
Balance Sheets by caption and level within the SFAS
157 valuation hierarchy (as described above) as of
December 31, 2008 and 2007, for which a
nonrecurring change in fair value has been recorded
during the reporting period.
Total assets at fair value on a nonrecurring basis
$
—
$
3,085
$
16,322
$
19,407
Accounts payable and other liabilities(b)
$
—
$
—
$
103
$
103
Total liabilities at fair value on a nonrecurring
basis
$
—
$
—
$
103
$
103
(a)
Includes leveraged lending and other loan warehouses held-for-sale.
(b)
Represents the fair value adjustment associated with $1.5 billion and $3.2 billion
of unfunded held-for-sale lending-related commitments within the leveraged lending
portfolio at December 31, 2008 and 2007, respectively.
(c)
Includes $4.5 billion of level 3 held-for-sale loans reclassified to
held-for-investment during 2007.
Nonrecurring fair value changes
The following table presents the total change in
value of financial instruments for which a fair
value adjustment has been included in the
Consolidated Statements of Income for the years
ended December 31, 2008 and 2007, related to
financial instruments held at December 31, 2008 and 2007.
Year ended December 31, (in millions)
2008
2007
Loans
$
(3,887
)
$
(720
)
Other assets
(685
)
(161
)
Accounts payable and other liabilities
(285
)
2
Total nonrecurring fair value gains (losses)
$
(4,857
)
$
(879
)
In the above table, loans predominantly include
the change in fair value for IB leveraged lending
and warehouse loans carried on the balance sheet at
the lower of cost or fair value; and accounts
payable and other liabilities predominantly include
the change in fair value for unfunded
lending-related commitments within the leveraged
lending portfolio.
Level 3 analysis
Level 3 assets (including assets measured at fair
value on a nonrecurring basis) were 6% of total
Firm assets at December 31, 2008. The following
describes significant changes to level 3 assets
during the year.
Level 3 assets increased $46.9 billion in 2008,
largely due to the following:
•
Acquisition of $41.5 billion of level 3 assets as a result of the merger with Bear
Stearns.
•
Acquisition of $5.9 billion of MSRs related to the Washington Mutual transaction.
•
Purchase of approximately $4.4 billion of reverse mortgages in the first quarter of
2008, for which there is limited pricing information and a lack of market liquidity.
•
Transfers of $14.0 billion of AAA-rated CLOs backed by corporate loans, based upon a
significant reduction in new deal issuance and price transparency; $10.5 billion of mortgage-related assets, including commercial mortgage-backed
securities with a rating below “AAA”, other noninvestment grade mortgage securities and
certain prime mortgages; and $2.8 billion of auction-rate
securities, in each case due to a
significant reduction in market liquidity.
The increases in level 3 assets described above were partially offset by:
•
Approximately $20.0 billion of sales and markdowns of residential mortgage-backed
securities, prime residential mortgage loans and Alt-A residential mortgage loans.
•
$11.5 billion of sales and markdowns of leveraged loans, as well as transfers of
similar loans to level 2 due to the increased price transparency for such assets.
$3.5 billion of transfers of bridge loans to level 2 due to increased price
transparency for such assets.
Gains and Losses
Gains and losses in the tables above for 2008 include:
•
Losses on trading debt and equity instruments of approximately $12.8 billion,
principally from mortgage-related transactions and auction-rate securities.
•
A $6.9 billion decline in the fair value of the MSR asset.
•
Losses of approximately $3.9 billion on leveraged loans.
Leveraged loans are typically classified as held-for-sale and measured at the lower of cost
or fair value and therefore included in the nonrecurring fair value assets.
•
Gains of $4.5 billion related to structured notes, principally due to significant
volatility in the equity markets.
•
Net gains of $4.6 billion related to derivatives, principally due to changes in
credit spreads and rate curves.
The Firm risk manages level 3 financial instruments
using securities and derivative positions
classified within level 1 or 2 of the valuation
hierarchy; the effect of these risk management
activities is not reflected in the level 3 gains
and losses included in the tables above.
For further information on changes in the fair
value of the MSRs, see Note 18 on pages 187–188 of
this Annual Report.
Credit adjustments
When determining the fair value of an instrument,
it may be necessary to record a valuation
adjustment to arrive at an exit price in
accordance with SFAS 157. Valuation adjustments
include, but are not limited to, amounts to
reflect counterparty credit quality and the Firm’s
own creditworthiness. For a detailed discussion of
the valuation adjustments the Firm considers, see
the valuation discussion at the beginning of this
Note.
The
following table provides the credit adjustments, gross of hedges
where risk is actively managed, as reflected
within the Consolidated Balance Sheets of the Firm
as of the dates indicated.
Year ended December 31, (in millions)
2008
2007
Derivatives receivables balance
$
162,626
$
77,136
Derivatives
CVA(a)
(9,566
)
(1,265
)
Derivatives payable balance
121,604
68,705
Derivatives DVA
1,389
518
Structured notes balance
67,340
87,622
Structured
notes DVA(b)
2,413
896
(a)
Derivative CVA, gross of hedges, includes results managed by Credit Portfolio and
other lines of business within IB.
(b)
Structured notes are carried at fair value based upon the Firm’s election under
SFAS 159. For further information on these elections, see Note 5 on page 144 of this
Annual Report.
The following table provides the impact of
credit adjustments, gross of hedges where risk is actively managed, on earnings in the respective periods.
Year ended December 31, (in millions)
2008
2007
Credit adjustments:
Derivatives CVA(a)
$
(7,561
)
$
(803
)
Derivatives DVA
789
514
Structured Notes DVA(b)
1,211
806
(a)
Derivative CVA, gross of hedges, includes results managed by Credit Portfolio and
other lines of business within IB.
(b)
Structured notes are carried at fair value based upon the Firm’s election under
SFAS 159. For further information on these elections, see Note 5 on page 144 of this
Annual Report.
The market’s view of the Firm’s credit quality
is reflected in credit spreads observed in the
credit default swap market. These credit spreads
are affected by a number of factors, such as the
performance of the assets the Firm holds.
Consequently, significant deterioration in the
value of sizable exposures held by the Firm are
likely to result in wider credit default swap
spreads. This will lead to an increase in the
Firm’s credit adjustment (i.e., DVA) for
liabilities carried at fair value.
Mortgage-related exposures carried at fair value
As noted above, certain of the Firm’s wholesale and consumer
loans are carried at fair value including mortgage related loans. Since the second half of 2007,
liquidity in certain sectors of the mortgage
markets has decreased, thereby limiting the price
transparency of certain mortgage-related
instruments. The table below summarizes the Firm’s
mortgage-related exposures that are carried at fair
value through earnings or at the lower of cost or
fair value; the table excludes securities held in
the available-for-sale portfolio.
Included exposures in IB and Retail Financial Services segments.
(b)
Excluded from the table above are certain mortgage-related assets that are carried
at fair value and recorded in trading assets, such as: (i) U.S. government agency and U.S.
government-sponsored enterprise securities that are liquid and of high credit quality of
$58.9 billion at December 31, 2008; and (ii) reverse mortgages of $4.3 billion at December 31,2008, for which the principal risk is mortality risk. Also excluded
are mortgage servicing rights,
which are reported in Note 18 on pages 187–188 of this Annual Report.
(c)
Also excluded from the table above are certain mortgage-related financing
transactions, which are collateralized by mortgage-related assets, of $5.7 billion at
December 31, 2008. These financing transactions are excluded from the table as they are
accounted for on an accrual basis of accounting. For financings deemed to be impaired,
impairment is measured and recognized based upon the fair value of the collateral. Of
these financing transactions, $1.2 billion at December 31, 2008, was considered impaired.
(d)
The amounts presented reflect the effects of derivatives utilized to risk manage
the gross exposures arising from cash-based instruments and are presented on a bond or
loan equivalent (notional) basis. Derivatives are excluded from
the gross exposure as they are principally used for risk management
purposes.
(e)
Net gains and losses include all revenue related to the positions (i.e., interest income, changes in fair value of the assets, changes in fair value of the related
risk management positions, and interest expense related to the liabilities funding
the positions).
Prime
Mortgage – The Firm had exposure of $11.2
billion to prime mortgages carried at fair value
through earnings or at the lower of cost or fair
value at December 31, 2008, which consisted of $2.9
billion of securities (including $1.2 billion of
forward purchase commitments), largely rated “AAA”,
and $8.3 billion of first-lien mortgages.
Alt-A
mortgage – The Firm had exposure of $3.9 billion to Alt-A mortgages carried at fair value
through earnings or at the lower of cost or fair
value at December 31, 2008, which consisted of
$787 million of securities and $3.1 billion of
first-lien mortgages.
Subprime
mortgage – The Firm had exposure of $941 million to sub-prime mortgages carried at fair
value through earnings or at the lower of cost or
fair value at December 31, 2008, which included
$680 million of securities and $261 million of
first-lien mortgages.
Classification and Valuation
Residential mortgage loans and mortgage-backed
securities are classified within level 2 or level 3
of the valuation hierarchy depending on the level
of liquidity and activity in the markets for a
particular product. Level 3 assets include
residential whole loans, prime and Alt-A
residential mortgage-backed securities rated below
“AAA”, subprime residential mortgage-backed
securities and single-name CDS on ABS. Products
that continue to have reliable price transparency
as evidenced by consistent market transactions,
such as AAA-rated prime and Alt-A securities, as
well as agency securities, continue to be
classified in level 2.
For those products classified within level 2 of
the valuation hierarchy, the Firm estimates the
value of such instruments using a combination of
observed transaction prices, independent pricing
services and relevant broker quotes. Consideration
is given to the nature of the quotes
(e.g., indicative or firm) and the relationship of
recently evidenced market activity to the prices
provided from independent pricing services.
When relevant market activity is not occurring or
is limited, the fair value is estimated as
follows:
Residential
mortgage loans – Fair value of
residential mortgage loans is estimated by
projecting the expected cash flows and discounting
those cash flows at a rate reflective of current
market liquidity. To estimate the projected cash
flows (inclusive of assumptions of prepayment,
default rates and loss severity), specific
consideration is given to both borrower-specific
and other market factors including, but not limited
to: the borrower’s FICO score; the type of
collateral supporting the loan; an estimate of the
current value of the collateral supporting the
loan; the level of documentation for the
loan; and market-derived expectations for home
price appreciation or depreciation in the
respective geography of the borrower.
Residential
mortgage-backed securities – Fair
value of residential mortgage-backed securities is
estimated considering the value of the collateral
and the specific attributes of the securities held
by the Firm. The value of the collateral pool
supporting the securities is
analyzed using the
same techniques and factors described above for
residential mortgage loans, albeit in a more
aggregated manner across the pool. For example,
average FICO scores, average delinquency rates,
average loss severities and prepayment rates, among
other metrics, may be evaluated. In addition, as
each securitization vehicle distributes cash in a
manner or order that is predetermined at the
inception of the vehicle, the priority in which
each particular mortgage-backed security is
allocated cash flows, and the level of credit
enhancement that is in place to support those cash
flows, are key considerations in deriving the value
of residential mortgage-backed securities. Finally,
the risk premium that investors demand for
securitized products in today’s market is factored
into the valuation. To benchmark its valuations,
the Firm looks to transactions for similar
instruments and utilizes independent pricing
provided by third-party vendors, broker quotes and
relevant market indices such as the ABX index, as
applicable. While none of those sources are solely
indicative of fair value, they serve as directional
indicators for the appropriateness of the Firm’s
estimates.
Commercial mortgages
Commercial mortgages are loans to companies backed
by commercial real estate. Commercial
mortgage-backed securities are securities
collateralized by a pool of commercial mortgages.
Typically, commercial mortgages have lock-out
periods, where the borrower is restricted from
prepaying the loan for a specified timeframe, or
periods where there are disincentives for the
borrower to prepay the loan due to prepayment
penalties. These features reduce prepayment risk
for commercial mortgages relative to that of
residential mortgages.
The Firm had exposure to $7.2 billion of
commercial mortgage-backed assets carried at fair
value through earnings or at the lower of cost or
fair value at December 31, 2008, which consisted
of $2.8 billion of securities, largely rated
“AAA”, and $4.4 billion of first-lien mortgages,
largely in the U.S.
Classification and Valuation
While commercial mortgages and commercial
mortgage-backed securities are classified within
level 2 or level 3 of the valuation hierarchy,
depending on the level of liquidity and activity in
the markets, the majority of these mortgages,
including both loans and lower-rated securities,
are currently classified in level 3. Level 2 assets
include AAA-rated fixed-rate commercial
mortgage-backed securities.
Commercial
mortgage loans – Fair value of
commercial mortgage loans is estimated by
projecting the expected
cash flows and discounting those cash flows at a
rate reflective of current market liquidity. To
estimate the projected cash flows, consideration is
given to both borrower-specific and other market
factors including, but not limited to: the
borrower’s debt-to-service coverage ratio; the type
of commercial property (e.g., retail, office,
lodging, multi-family, etc.); an estimate of the
current loan-to-value ratio; and market-derived
expectations for property price appreciation or
depreciation in the respective geographic location.
Commercial
mortgage-backed securities – When
relevant market activity is not present or is
limited, the value of commercial mortgage-backed
securities is estimated considering the value of
the collateral and the specific attributes of the
securities held by the Firm. The value of the
collateral pool supporting the securities is
analyzed using the same techniques and factors
described above for the valuation of commercial
mortgage loans, albeit in a more aggregated manner
across the pool. For example, average
delinquencies, loan or geographic concentrations
and average debt-service coverage ratios, among
other metrics, may be evaluated. In addition, as
each securitization vehicle distributes cash in a
manner or order that is predetermined at the
inception of the vehicle, the priority in which
each
particular mortgage-backed security is
allocated cash flows, and the level of credit
enhancement that is in place to support those cash
flows, are key considerations in deriving the value
of commercial mortgage-backed securities. Finally,
the risk premium that investors demand for
securitized products in today’s market is factored
into the valuation. To benchmark its valuations,
the Firm utilizes independent pricing provided by
third-party vendors, and broker quotes, as
applicable. While none of those sources are solely
indicative of fair value, they serve as directional
indicators for the appropriateness of the Firm’s
estimates.
The following table presents mortgage-related activities within the available-for-sale securities
portfolio.
Exposures in the table above include $140.1
billion of mortgage-backed securities classified as
available-for-sale in the Firm’s Consolidated
Balance Sheets at December 31, 2008. These
investments are primarily used as part of the Firm’s
centralized risk management of structural interest
rate risk (the sensitivity of the Firm’s aggregate
balance sheet to changes in interest rates).
Changes in the Firm’s structural interest rate
position, as well as changes in the overall
interest rate environment, are continually
monitored, resulting in periodic repositioning of
mortgage-backed securities classified as
available-for-sale. Given that this portfolio is
primarily used to manage interest rate risk,
predominantly all of these securities are backed by
either U.S. government agencies, government
sponsored entities, or they are rated “AAA”.
Investment securities in the available-for-sale portfolio include:
•
$6.9 billion of prime and Alt-A securities, principally rated “AAA”. The fair value
of these securities is determined based upon independent pricing services supported by
relevant and observable market data for similar securities. The Firm classifies these
securities in level 2 of the valuation hierarchy.
•
$3.9 billion of commercial mortgage-backed securities, principally rated “AAA”. The
fair value of these securities is determined using a third party pricing service that
uses relevant and observable market data. The Firm classifies these securities in level 2
of the valuation hierarchy.
•
$127.0 billion of U.S. government agencies or U.S. government-sponsored enterprise
mortgage-backed securities. Where these securities trade in active markets and there is
market-observable pricing, they are classified in level 1 of the valuation hierarchy.
Where the determination of fair value is based on broker quotes and independent pricing
services, supported by relevant and observable
market data, the Firm classifies such securities in level 2 of the valuation hierarchy.
SFAS 157 Transition
In connection with the initial adoption of
SFAS 157, the Firm recorded the following on
January 1, 2007:
•
a cumulative effect increase to retained earnings of $287 million, primarily
related to the release of profit previously deferred in accordance with EITF 02-3;
•
an increase to pretax income of $166 million ($103 million after-tax) related to the
incorporation of the Firm’s creditworthiness in the valuation of liabilities recorded at
fair value; and
•
an increase to pretax income of $464 million ($288 million after-tax) related to
valuations of nonpublic private equity investments.
Prior to the adoption of SFAS 157, the Firm applied
the provisions of EITF 02-3 to its derivative
portfolio. EITF 02-3 precluded the recognition of
initial trading profit in the absence of: (a)
quoted market prices, (b) observable prices of
other current market transactions or (c) other
observable data supporting a valuation technique.
In accordance with EITF 02-3, the Firm recognized
the deferred profit in principal transactions
revenue on a systematic basis (typically
straight-line amortization over the life of the
instruments) and when observable market data became
available.
Prior to the adoption of SFAS 157 the Firm did not
incorporate an adjustment into the valuation of
liabilities carried at fair value on the
Consolidated Balance Sheets. Commencing January 1,2007, in accordance with the requirements of SFAS
157, an adjustment was made to the valuation of
liabilities measured at fair value to reflect the
credit quality of the Firm.
Prior to the adoption of SFAS 157, privately held
investments were initially valued based upon cost.
The carrying values of privately held investments
were adjusted from cost to reflect both positive
and negative changes evidenced by financing events
with third-party capital providers. The investments
were also subject to ongoing impairment reviews by
private equity senior investment professionals. The
increase in pretax income related to nonpublic
private equity investments in connection with the
adoption of SFAS 157 was due to there being
sufficient market evidence to support an
increase in fair values using the SFAS 157
methodology, although there had not been an actual
third-party market transaction related to such
investments.
Financial disclosures required by SFAS 107
Many but not all of the financial instruments held
by the Firm are recorded at fair value on the
Consolidated Balance Sheets. SFAS 107 requires
disclosure of the estimated fair value of certain
financial instruments and the methods and
significant assumptions used to estimate their fair
value. Financial instruments within the scope of
SFAS 107 are included in the table below.
Additionally, certain financial instruments and all
nonfinancial instruments are excluded from the
scope of SFAS 107. Accordingly, the fair value
disclosures required by SFAS 107 provide only a
partial estimate of the fair value of JPMorgan
Chase. For example, the Firm has developed
long-term relationships with its customers through
its deposit base and credit card accounts, commonly
referred to as core deposit intangibles and credit
card relationships. In the opinion of management,
these items, in the aggregate, add significant
value to JPMorgan Chase, but their fair value is
not disclosed in this Note.
Financial instruments for which fair value
approximates carrying value
Certain financial instruments that are not carried
at fair value on the Consolidated Balance Sheets
are carried at amounts that approximate fair value
due to their short-term nature and generally
negligible credit risk. These instruments include
cash and due from banks, deposits with banks,
federal funds sold and securities purchased under
resale agreements and securities borrowed with short-dated maturities,
short-term receivables and
accrued interest receivable, commercial paper,
federal funds purchased and securities loaned or sold under
repurchase agreements with short-dated maturities,
other borrowed funds (excluding advances from Federal Home Loan Banks), accounts payable and accrued
liabilities. In addition, SFAS 107 requires that
the fair value for deposit liabilities with no
stated maturity (i.e., demand, savings and certain
money market deposits) be equal to their carrying
value. SFAS 107 does not allow for the recognition
of the inherent funding value of these instruments.
The following table presents the carrying value and estimated fair value of financial assets
and liabilities as required by SFAS 107 (a discussion of the valuation of the individual
instruments can be found at the beginning of this Note or following the table below).
2008
2007
Carrying
Estimated
Appreciation/
Carrying
Estimated
Appreciation/
December 31, (in billions)
value
fair value
(depreciation)
value
fair value
(depreciation)
Financial assets
Assets for which fair value approximates carrying value
$
226.0
$
226.0
$
—
$
76.4
$
76.4
$
—
Federal funds sold and securities purchased under resale
agreements (included $20.8 and $19.1 at fair value at
December 31, 2008 and 2007, respectively)
203.1
203.1
—
170.9
170.9
—
Securities
borrowed (included $3.4 and zero at fair value at December 31, 2008 and 2007, respectively)
124.0
124.0
—
84.2
84.2
—
Trading assets
510.0
510.0
—
491.4
491.4
—
Securities
205.9
205.9
—
85.4
85.4
—
Loans (included $7.7 and $8.7 at fair value at
December 31, 2008 and 2007, respectively)
721.7
700.0
(21.7
)
510.1
510.7
0.6
Mortgage servicing rights at fair value
9.4
9.4
—
8.6
8.6
—
Other (included $29.2 and $22.2 at fair value at
December 31, 2008 and 2007, respectively)
104.6
104.7
0.1
66.6
67.1
0.5
Total financial assets
$
2,104.7
$
2,083.1
$
(21.6
)
$
1,493.6
$
1,494.7
$
1.1
Financial liabilities
Deposits (included $5.6 and $6.4 at fair value at
December 31, 2008 and 2007, respectively)(a)
$
1,009.3
$
1,010.2
$
(0.9
)
$
740.7
$
741.3
$
(0.6
)
Federal funds purchased and securities loaned or sold
under
repurchase agreements (included $3.0 and $5.8 at fair
value at
December 31, 2008 and 2007, respectively)
192.5
192.5
—
154.4
154.4
—
Commercial paper
37.8
37.8
—
49.6
49.6
—
Other borrowed funds (included $14.7 and $10.8 at fair
value at
December 31, 2008 and 2007, respectively)
132.4
134.1
(1.7
)
28.8
28.8
—
Trading liabilities
166.9
166.9
—
157.9
157.9
—
Accounts payable and other liabilities
183.3
183.3
—
89.0
89.0
—
Beneficial interests issued by consolidated VIEs
(included $1.7 and
$3.0 at fair value at December 31, 2008 and 2007,
respectively)
10.6
10.5
0.1
14.0
13.9
0.1
Long-term debt and junior subordinated deferrable
interest debentures
(included $58.2 and $70.5 at fair value at December 31,2008
and 2007, respectively)(b)
270.7
262.1
8.6
199.0
198.7
0.3
Total financial liabilities
$
2,003.5
$
1,997.4
$
6.1
$
1,433.4
$
1,433.6
$
(0.2
)
Net (depreciation) appreciation
$
(15.5
)
$
0.9
(a)
The fair value of interest-bearing deposits are estimated by discounting cash
flows using the appropriate market rates for the applicable maturity.
(b)
Fair value for long-term debt, including junior subordinated deferrable interest
debentures held by trusts that issued guaranteed capital debt securities, is based upon
current market rates and adjusted for JPMorgan Chase’s credit quality.
The majority of the Firm’s unfunded
lending-related commitments are not carried at fair
value on a recurring basis on the Consolidated
Balance Sheets nor are they actively traded.
Although there is no liquid secondary market for
wholesale commitments, the Firm estimates the fair
value of its wholesale lending-related commitments
primarily using the cost of credit derivatives
(which is adjusted to account for the difference in
recovery rates between bonds, upon which the cost
of credit derivatives is based, and loans) and loan
equivalents (which represent the portion of an
unused commitment expected, based
upon the Firm’s average portfolio historical
experience, to become outstanding in the event an
obligor defaults). On this basis, the estimated
fair value of the Firm’s lending-related
commitments at December 31, 2008 and 2007, was a
liability of $7.5 billion and
$1.9 billion, respectively. The Firm does not
estimate the fair value of consumer lending-related
commitments. In many cases, the Firm can reduce or
cancel these commitments by providing the borrower
prior notice, or, in some cases, without notice as
permitted by law.
In February 2007, the FASB issued SFAS 159,
which was effective for fiscal years beginning
after November 15, 2007, with early adoption
permitted. The Firm chose early adoption for SFAS
159 effective January 1, 2007. SFAS 159 provides an
option to elect fair value as an alternative
measurement for selected financial assets,
financial liabilities, unrecognized firm
commitments, and written loan commitments not
previously carried at fair value.
Elections
The following is a discussion of the primary
financial instruments for which fair value
elections were made and the basis for those
elections:
Loans and unfunded lending-related commitments
On January 1, 2007, the Firm elected to record, at
fair value, the following:
•
Loans and unfunded lending-related commitments that are extended as part of IB’s
principal investing activities. The transition amount related to these loans included a
reversal of the allowance for loan losses of $56 million.
•
Certain loans held-for-sale. These loans were reclassified to trading assets – debt
and equity instruments. This election enabled the Firm to record loans purchased as part
of the Investment Bank’s commercial mortgage securitization activity and proprietary
activities at fair value and discontinue SFAS 133 fair value hedge relationships for
certain originated loans.
Beginning on January 1, 2007, the Firm chose to
elect fair value as the measurement attribute for
the following loans originated or purchased after
that date:
•
Loans purchased or originated as part of IB’s securitization warehousing
activities.
•
Prime mortgage loans originated with the intent to sell within Retail Financial
Services (“RFS”).
The election to fair value the above loans did
not include loans within these portfolios that
existed on January 1, 2007, based upon the short
holding period of the loans and/or the negligible
impact of the elections.
Warehouse loans elected to be reported at fair
value are classified as trading assets – debt and
equity instruments. For additional information
regarding warehouse loans, see Note 16 on pages
168–176 of this Annual Report.
Beginning in the third quarter of 2007, the Firm
elected the fair value option for newly originated
bridge financing activity in IB. These elections
were made to align further the accounting basis of
the bridge financing activities with their related
risk management practices. For these activities,
the loans continue to be classified within loans on
the Consolidated Balance Sheets; the fair value of
the unfunded commitments is recorded within
accounts payable and other liabilities.
Securities Financing Arrangements
On January 1, 2007, the Firm elected to record at
fair value resale and repurchase agreements with
an embedded derivative or a maturity of greater
than one year. The intent of this election was to
mitigate volatility due to the differences in the
measurement basis for the agreements (which were
previously accounted for on an accrual basis) and
the associated risk management arrangements (which
are accounted for on a fair value basis). An
election was not made for short-term agreements,
as the carrying value for such agreements
generally approximates fair value. For additional
information regarding these agreements, see Note
13 on pages 162–163 of this Annual Report.
In the second quarter of 2008, the Firm began
electing the fair value option for newly transacted
securities borrowed and securities lending
agreements with a maturity of greater than one
year. An election was not made for any short-term
agreements, as the carrying value for such
agreements generally approximates fair value.
Structured Notes
IB issues structured notes as part of its
client-driven activities. Structured notes are
financial instruments that contain embedded
derivatives and are included in long-term debt. On
January 1, 2007, the Firm elected to record at fair
value all structured notes not previously elected
or eligible for election under SFAS 155. The
election was made to mitigate the volatility due to
the differences in the measurement basis for
structured notes and the associated risk management
arrangements as well as to eliminate the
operational burdens of having different accounting
models for the same type of financial instrument.
Other
In the third quarter of 2008, the Firm elected
the fair value option for the ABCP investments
purchased under the Federal Reserve’s AML
Facility for U.S. money market mutual funds, as
well as the related nonrecourse advance from the
Federal Reserve Bank of Boston (“FRBB”). At
December 31, 2008, ABCP investments of
$11.2 billion were recorded in other assets; the
corresponding non-recourse liability to the FRBB
in the same amount was recorded in other borrowed
funds. For further discussion, see Note 21 on page
190 of this Annual Report.
In 2008, the Firm elected the fair value option for
certain loans acquired as part of the Bear Stearns
merger that were included in the trading portfolio
and for prime mortgages previously designated as
held-for-sale by Washington Mutual as part of the
Washington Mutual transaction. In addition, the
Firm elected the fair value option for certain tax
credit and other equity investments acquired as
part of the Washington Mutual transaction.
Changes in fair value under the fair value option election
The following table presents the changes in fair value included in the Consolidated Statements of
Income for the years ended December 31, 2008 and 2007, for items for which the fair value election
was made. The
profit and loss information presented below only includes the financial instruments that were
elected to be measured at fair value; related risk management instruments, which are required to be
measured at fair value, are not included in the table.
2008
2007
Principal
Other
Total changes in
Principal
Other
Total changes in
December 31, (in millions)
transactions(c)
income(c)
fair value recorded
transactions(c)
income(c)
fair value recorded
Federal funds sold and securities purchased under
resale agreements
$
1,139
$
—
$
1,139
$
580
$
—
$
580
Securities borrowed
29
—
29
—
—
—
Trading assets:
Debt and equity instruments, excluding loans
(870
)
(58
)(d)
(928
)
421
(1
)(d)
420
Loans reported as trading assets:
Changes in instrument-specific credit risk
(9,802
)
(283
)(d)
(10,085
)
(517
)
(157
)(d)
(674
)
Other changes in fair value
696
1,178
(d)
1,874
188
1,033
(d)
1,221
Loans:
Changes in instrument-specific credit risk
(1,991
)
—
(1,991
)
102
—
102
Other changes in fair value
(42
)
—
(42
)
40
—
40
Other assets
—
(660
)(e)
(660
)
—
30
(e)
30
Deposits(a)
(132
)
—
(132
)
(906
)
—
(906
)
Federal funds purchased and securities loaned or
sold under repurchase agreements
(127
)
—
(127
)
(78
)
—
(78
)
Other borrowed funds(a)
1,888
—
1,888
(412
)
—
(412
)
Trading liabilities
35
—
35
(17
)
—
(17
)
Accounts payable and other liabilities
—
—
—
(460
)
—
(460
)
Beneficial interests issued by consolidated VIEs
355
—
355
(228
)
—
(228
)
Long-term debt:
Changes in instrument-specific credit risk(a)
1,174
—
1,174
771
—
771
Other changes in fair value(b)
16,202
—
16,202
(2,985
)
—
(2,985
)
(a)
Total changes in instrument-specific credit risk related to structured notes were
$1.2 billion and $806 million for the years ended December 31, 2008 and 2007,
respectively, which includes adjustments for structured notes classified within deposits
and other borrowed funds, as well as long-term debt.
(b)
Structured notes are debt instruments with embedded derivatives that are tailored
to meet a client’s need for derivative risk in funded form. The embedded derivative is the
primary driver of risk. The 2008 gain included in “Other changes in fair value” results
from a significant decline in the value of certain structured notes where the embedded
derivative is principally linked to either equity indices or commodity prices, both of
which declined sharply during the second half of 2008. Although the risk associated with
the structured notes is actively managed, the balance reported in
this table does not include
the income statement impact of such risk management instruments.
(c)
Included in the amounts are gains and losses related to certain financial
instruments previously carried at fair value by the Firm, such as structured liabilities
elected pursuant to SFAS 155 and loans purchased as part of the Investment Bank’s trading
activities.
(d)
Reported in mortgage fees and related income.
(e)
Reported in other income.
Determination of instrument-specific credit
risk for items for which a fair value election
was made
The following describes how the gains and losses
included in earnings during 2008 and 2007, which
were attributable to changes in
instrument-specific credit risk, were determined.
•
Loans and lending-related commitments: For floating-rate instruments, all changes in
value are
attributed to instrument-specific credit risk. For fixed-rate instruments, an allocation of
the changes in value for the period is made between those changes in value that are
interest rate-related and changes in value that are credit-related. Allocations are
generally based upon an analysis of borrower-specific credit spread and recovery
information, where available, or benchmarking to similar entities or industries.
•
Long-term debt: Changes in value attributable to instrument-specific credit risk
were derived principally from observable changes in the Firm’s credit spread. The gain for
2008 and 2007 was attributable to the widening of the Firm’s credit spread.
•
Resale and repurchase agreements, securities borrowed agreements and securities
lending agreements: Generally, for these types of agreements, there is a requirement that
collateral be maintained with a market value equal to or in excess of the principal amount
loaned; as a result, there would be no adjustment or an immaterial adjustment for
instrument-specific credit risk related to these agreements.
Difference between aggregate fair value and
aggregate remaining contractual principal
balance outstanding
The following table reflects the difference between
the aggregate fair value and the aggregate
remaining contractual principal balance outstanding
as of December 31, 2008 and 2007, for loans and
long-term debt for which the SFAS 159 fair value
option has been elected. The loans were classified
in trading assets – debt and equity instruments or
in loans.
Remaining contractual principal is not applicable to nonprincipal protected notes.
Unlike principal protected notes for which the Firm is obligated to return a stated amount
of principal at the maturity of the note, nonprincipal protected notes do not obligate the
Firm to return a stated amount of principal at maturity but to return an amount based upon
the performance of an underlying variable or derivative feature embedded in the note.
(b)
Where the Firm issues principal protected zero coupon or discount notes, the
balance reflected as the remaining contractual principal is the final principal payment at
maturity.
The contractual amount of unfunded
lending-related commitments for which the fair
value option was elected was negligible at December31, 2008. At December 31, 2007, the contractual
amount of unfunded lending-related commitments for
which the fair value option was elected was $1.0
billion with a corresponding fair value of $25
million. Such commitments are reflected as
liabilities and included in accounts payable and
other liabilities.
Note 6 – Principal transactions
Principal transactions revenue consists of
realized and unrealized gains and losses from
trading activities (including physical commodities
inventories that are accounted for at the lower of
cost or fair value), changes in fair value
associated with financial instruments held by the
Investment Bank for which the SFAS 159 fair value
option was elected, and loans held-for-sale within
the wholesale lines of business. For loans measured
at fair value under SFAS 159, origination costs are
recognized in the associated expense category as
incurred. Principal transactions revenue also
includes private equity gains and losses.
The following table presents principal transactions revenue.
Year ended December 31, (in millions)
2008
2007
2006
Trading revenue
$
(9,791
)
$
4,736
$
9,418
Private
equity gains (losses)(a)
(908
)
4,279
1,360
Principal transactions
$
(10,699
)
$
9,015
$
10,778
(a)
Includes revenue on private equity investments held in the Private Equity business
within Corporate/Private Equity and those held in other business segments.
Trading assets and liabilities
Trading assets include debt and equity instruments
held for trading purposes that JPMorgan Chase owns
(“long” positions), certain loans for which the
Firm manages on a fair value basis and has elected
the SFAS 159 fair value option, and physical
commodities inventories that are accounted for at
the lower of cost or fair value.
Trading liabilities include debt and equity
instruments that the Firm has sold to other parties
but does not own (“short” positions). The Firm is
obligated to purchase instruments at a future date
to cover the short positions. Included in trading
assets and trading liabilities are the reported
receivables (unrealized gains) and payables
(unrealized losses) related to derivatives. Trading
assets and liabilities are carried at fair value on
the Consolidated Balance Sheets. For a discussion
of the valuation of trading assets and trading
liabilities, see Note 5 on pages 144–146 of this
Annual Report.
The following table presents the fair value of
trading assets and trading liabilities for the
dates indicated.
December 31, (in millions)
2008
2007
Trading assets
Debt and equity instruments:(a)
U.S. government and federal agency obligations:
U.S. treasuries
$
22,121
$
32,378
Mortgage-backed securities
6,037
791
Agency obligations
35
2,264
U.S. government-sponsored enterprise obligations:
Mortgage-backed securities
52,871
33,910
Direct obligations
9,149
9,928
Obligations of state and political subdivisions
13,002
13,090
Certificates of deposit, bankers’ acceptances
and commercial paper
7,492
8,252
Debt securities issued by non-U.S. governments
38,647
67,921
Corporate debt securities
60,323
53,941
Equity securities
78,546
93,248
Loans
31,802
57,814
Mortgage-backed securities:
Prime
1,725
6,136
Alt-A
787
3,572
Subprime
680
1,459
Non-U.S. residential
805
974
Commercial
2,816
8,256
Asset-backed securities:
Credit card receivables
1,296
321
Automobile loans
722
605
Other consumer loans
1,343
2,675
Commercial and industrial loans
1,604
169
Collateralized debt obligations
3,868
4,879
Other
687
1,026
Physical commodities
3,581
4,490
Other
7,418
6,174
Total debt and equity instruments
347,357
414,273
Derivative receivables:
Interest rate
64,101
36,020
Credit
44,695
22,083
Commodity
14,830
9,419
Foreign exchange
24,715
5,616
Equity
14,285
3,998
Total derivative receivables
162,626
77,136
Total trading assets
$
509,983
$
491,409
December 31, (in millions)
2008
2007
Trading liabilities
Debt and equity instruments(b)
$
45,274
$
89,162
Derivative payables:
Interest rate
48,449
25,542
Credit
23,566
11,613
Commodity
11,921
6,942
Foreign exchange
20,352
7,552
Equity
17,316
17,056
Total derivative payables
121,604
68,705
Total trading liabilities
$
166,878
$
157,867
(a)
Prior periods have been revised to reflect the current presentation.
(b)
Primarily represents securities sold, not yet purchased.
Included in trading assets and trading
liabilities are the reported receivables
(unrealized gains) and payables (unrealized losses)
related to derivatives. As permitted under FIN 39,
the Firm has elected to net derivative receivables
and derivative payables and the related cash
collateral received and paid when a legally
enforceable master netting agreement exists. The
netted amount of cash collateral received and paid
was $103.6 billion and $72.4 billion, respectively,
at December 31, 2008, and $34.9 billion and $24.6
billion, respectively, at December 31, 2007. The
Firm received and paid excess collateral of $22.2
billion and $3.7 billion, respectively, at December31, 2008, and $17.4 billion and $2.4 billion,
respectively, at December 31, 2007. This additional
collateral received and paid secures potential
exposure that could arise in the derivatives
portfolio should the mark-to-market of the
transactions move in the Firm’s favor or the
client’s favor, respectively, and is not nettable
against the derivative receivables or payables in
the table above. The above amounts also exclude
liquid securities held and posted as collateral by
the Firm to secure derivative receivables and
derivative payables. Collateral amounts held and posted in
securities form are not recorded on the Firm’s
balance sheet, and are therefore not nettable
against derivative receivables. The Firm held
securities collateral of $19.8 billion and $9.8
billion at December 31, 2008 and 2007,
respectively, related to derivative receivables.
The Firm posted $11.8 billion and $5.9 billion of
securities collateral at December 31, 2008 and
2007, respectively, related to derivative
payables.
Average trading assets and liabilities were as
follows for the periods indicated.
Year ended December 31, (in millions)
2008
2007
2006
Trading assets – debt and equity instruments
$
384,102
$
381,415
$
280,079
Trading assets – derivative receivables
121,417
65,439
57,368
Trading liabilities – debt and equity instruments(a)
$
78,841
$
94,737
$
102,794
Trading liabilities – derivative payables
93,200
65,198
57,938
(a)
Primarily represent securities sold, not yet purchased.
Private equity investments
Private equity investments are recorded in other
assets on the Consolidated Balance Sheets. The
following table presents the carrying value and
cost of the private equity investment portfolio
held by the Private Equity business within
Corporate/Private Equity for the dates indicated.
The above private equity investments include
investments in buyouts, growth equity and venture
opportunities. These investments are accounted for
under investment company guidelines. Accordingly,
these investments, irrespective of the percentage
of equity ownership interest held, are carried on
the Consolidated Balance Sheets at fair value.
Realized and unrealized gains and losses arising
from changes in fair
value are reported in principal transactions
revenue in the Consolidated Statements of Income in
the period that the gains or losses are recognized.
For a discussion of the valuation of private equity
investments, see Note 5 on pages 144–146 of this
Annual Report.
Note 7
– Other noninterest revenue
Investment banking fees
This revenue category includes advisory and equity
and debt underwriting fees. Advisory fees are
recognized as revenue when the related services
have been performed. Underwriting fees are
recognized as revenue when the Firm has rendered
all services to the issuer and is entitled to
collect the fee from the issuer, as long as there
are no other contingencies associated with the fee
(e.g., the fee is not contingent upon the customer
obtaining financing). Underwriting fees are net of
syndicate expense; the Firm recognizes credit
arrangement and syndication fees as revenue after
satisfying certain retention, timing and yield
criteria.
The following table presents the components of Investment banking fees.
Year ended December 31, (in millions)
2008
2007
2006
Underwriting:
Equity
$
1,477
$
1,713
$
1,179
Debt
2,094
2,650
2,703
Total underwriting
3,571
4,363
3,882
Advisory
1,955
2,272
1,638
Total investment banking fees
$
5,526
$
6,635
$
5,520
Lending & deposit-related fees
This revenue category includes fees from loan
commitments, standby letters of credit, financial
guarantees, deposit-related fees in lieu of
compensating balances, cash management-related
activities or transactions, deposit accounts and
other loan-servicing activities. These fees are
recognized over the period in which the related
service is provided.
Asset management, administration and commissions
This revenue category includes fees from investment
management and related services, custody, brokerage
services, insurance premiums and commissions, and
other products. These fees are recognized over the
period in which the related service is provided.
Performance-based fees, which are earned based upon
exceeding certain benchmarks or other performance
targets, are accrued and recognized at the end of
the performance period in which the target is met.
The following table presents components of
asset management, administration and
commissions.
Year ended December 31, (in millions)
2008
2007
2006
Asset management:
Investment management fees
$
5,562
$
6,364
$
4,429
All other asset management fees
432
639
567
Total asset management fees
5,994
7,003
4,996
Total administration fees(a)
2,452
2,401
2,430
Commission and other fees:
Brokerage commissions
3,141
2,702
2,184
All other commissions and fees
2,356
2,250
2,245
Total commissions and fees
5,497
4,952
4,429
Total asset management,
administration and commissions
$
13,943
$
14,356
$
11,855
(a)
Includes fees for custody, securities lending, funds services and broker-dealer clearance.
Mortgage fees and related income
This revenue category primarily reflects Retail
Financial Services’ mortgage banking revenue,
including: fees and income derived from mortgages
originated with the intent to sell; mortgage sales
and servicing; the impact of risk management
activities associated with the mortgage pipeline,
warehouse loans and MSRs; and revenue related to
any residual interests held from mortgage
securitizations. This revenue category also
includes gains and losses on sales and lower of
cost or fair value adjustments for mortgage loans
held-for-sale, as well as changes in fair value for
mortgage loans originated with the intent to sell
and measured at fair value under SFAS 159. For
loans measured at fair value under SFAS 159,
origination costs are recognized in the associated
expense category as incurred. Costs to originate
loans held-for-sale and accounted for at the lower
of cost or fair value are deferred and recognized
as a component of the gain or loss on sale. Net
interest
income from mortgage loans and securities gains and
losses on available-for-sale (“AFS”) securities
used in mortgage-related risk management activities
are recorded in interest income and securities
gains (losses), respectively. For a further
discussion of MSRs, see Note 18 on pages 187–188
of this Annual Report.
Credit card income
This revenue category includes interchange income
from credit and debit cards and servicing fees
earned in connection with securitization
activities. Volume-related payments to partners and
expense for rewards programs are netted against
interchange income; expense related to rewards
programs are recorded when the rewards are earned
by the customer, as more fully described below.
Other fee revenue is recognized as earned, except
for annual fees, which are deferred and recognized
on a straight-line basis over the 12-month period
to which they pertain. Direct loan origination
costs are also deferred and recognized over a
12-month period. In addition, due to the
consolidation of Chase Paymentech Solutions in the
fourth quarter of 2008, this category now includes
net fees earned for processing card transactions
for merchants.
Credit card revenue sharing agreements
The Firm has contractual agreements with numerous
affinity organizations and co-brand partners, which
grant the Firm exclusive rights to market to the
members or customers of such organizations and
partners. These organizations and partners endorse
the credit card programs and provide their mailing
lists to the Firm, and they may also conduct
marketing activities and provide awards under the
various credit card programs. The terms of these
agreements generally range from three to ten years.
The economic incentives the Firm pays to the
endorsing organizations and partners typically
include payments based upon new account
originations, charge volumes, and the cost of the
endorsing organizations’ or partners’ marketing
activities and awards.
The Firm recognizes the payments made to the
affinity organizations and co-brand partners based
upon new account originations as direct loan
origination costs. Payments based upon charge
volumes are considered by the Firm as revenue
sharing with the affinity organizations and
co-brand partners, which are deducted from
interchange income as the related revenue is
earned. Payments based upon marketing efforts
undertaken by the endorsing organization or partner
are expensed by the Firm as incurred. These costs
are recorded within noninterest expense.
Note 8 – Interest income and Interest expense
Details of interest income and interest expense were as follows.
Year ended December 31, (in millions)
2008
2007
2006
Interest income(a)
Loans(b)
$
38,347
$
36,660
$
33,121
Securities(b)
6,344
5,232
4,147
Trading assets
17,236
17,041
10,942
Federal funds sold and securities
purchased under resale agreements
5,983
6,497
5,578
Securities borrowed
2,297
4,539
3,402
Deposits with banks
1,916
1,418
1,265
Interests in purchased receivables(b)
—
—
652
Other assets(c)
895
—
—
Total interest income
73,018
71,387
59,107
Interest expense(a)
Interest-bearing deposits
14,546
21,653
17,042
Short-term and other liabilities(d)
10,933
16,142
14,086
Long-term debt
8,355
6,606
5,503
Beneficial interests issued by
consolidated VIEs
405
580
1,234
Total interest expense
34,239
44,981
37,865
Net interest income
38,779
26,406
21,242
Provision for credit losses
19,445
6,864
3,270
Provision for credit losses –
accounting conformity(e)
1,534
—
—
Total provision for credit losses
$
20,979
$
6,864
$
3,270
Net interest income after provision
for credit losses
$
17,800
$
19,542
$
17,972
(a)
Interest income and interest expense include the current period interest accruals
for financial instruments measured at fair value except for financial instruments
containing embedded derivatives that would be separately accounted for in accordance with
SFAS
133 absent the SFAS 159 fair value election; for those instruments, all changes in fair
value, including any interest elements, are reported in principal transactions revenue.
(b)
As a result of restructuring certain multi-seller conduits the Firm administers,
JPMorgan Chase deconsolidated $29 billion of interests in purchased receivables, $3
billion of loans and $1 billion of securities and recorded $33 billion of lending-related
commitments during 2006.
(c)
Predominantly margin loans.
(d)
Includes brokerage customer payables.
(e)
Includes accounting conformity loan loss reserve provision related to the
acquisition of Washington Mutual’s banking operations.
Note 9 – Pension and other postretirement
employee benefit plans
The Firm’s defined benefit pension plans are
accounted for in accordance with SFAS 87 and SFAS
88, and its other postretirement employee benefit
(“OPEB”) plans are accounted for in accordance
with SFAS 106. In September 2006, the FASB issued
SFAS 158, which requires companies to recognize on
their Consolidated Balance Sheets the overfunded
or underfunded status of their defined benefit
postretirement plans, measured as the difference
between the fair value of plan assets and the
benefit obligation. SFAS 158 requires unrecognized
amounts (e.g., net loss and prior service costs)
to be recognized in accumulated other
comprehensive income (loss) (“AOCI”) and that
these amounts be adjusted as they are subsequently
recognized as components of net periodic benefit
cost based upon the current amortization and
recognition
requirements of SFAS 87 and SFAS 106. The Firm
prospectively adopted SFAS 158 on December 31,2006, and recorded an after-tax charge to AOCI of
$1.1 billion at that date.
SFAS 158 also eliminates the provisions of SFAS 87
and SFAS 106 that allow plan assets and
obligations to be measured as of a date not more
than three months prior to the reporting entity’s
balance sheet date. The Firm uses a measurement
date of December 31 for its defined benefit
pension and OPEB plans; therefore, this provision
of SFAS 158 had no effect on the Firm’s financial
statements.
For the Firm’s defined benefit pension plans, fair
value is used to determine the expected return on
plan assets. For the Firm’s OPEB plans, a
calculated value that recognizes changes in fair
value over a five-year period is used to determine
the expected return on plan assets. Amortization of
net gains and losses is included in annual net
periodic benefit cost if, as of the beginning of
the year, the net gain or loss exceeds 10 percent
of the greater of the projected benefit obligation
or the fair value of the plan assets. Any excess,
as well as prior service costs, are amortized over
the average future service period of defined
benefit pension plan participants, which for the
U.S. defined benefit pension plan is currently nine
years (the decrease of one year from the prior year
in the assumptions is related to pension plan
demographic assumption revisions at December 31,2007, to reflect recent experience relating to the
form and timing of benefit distributions and rates
of turnover). For OPEB plans, any excess net gains
and losses also are amortized over the average
future service period, which is currently six
years; however, prior service costs are amortized
over the average years of service remaining to full
eligibility age, which is currently four years. The
amortization periods for net gains and losses and
prior service costs for OPEB are unchanged from the
prior year.
Defined benefit pension plans
The Firm has a qualified noncontributory U.S.
defined benefit pension plan that provides benefits
to substantially all U.S. employees. The U.S. plan
employs a cash balance formula in the form of pay
and interest credits to determine the benefits to
be provided at retirement, based upon eligible
compensation and years of service. Employees begin
to accrue plan benefits after completing one year
of service, and beginning January 1, 2008, benefits
generally vest after three years of service. The
Firm also offers benefits through defined benefit
pension plans to qualifying employees in certain
non-U.S. locations based upon factors such as
eligible compensation, age and/or years of service.
It is the Firm’s policy to fund the pension plans
in amounts sufficient to meet the requirements
under
applicable employee benefit and local tax laws. On
January 15, 2009, the Firm made a discretionary
cash contribution to its U.S. defined benefit
pension plan of $1.3 billion, funding the plan to
the maximum allowable amount under applicable tax
law. The expected amount of 2009 contributions to
its non-U.S. defined benefit pension plans is $44
million, of which $20 million is contractually
required. The amount of potential 2009
contributions to the United Kingdom (“U.K.”) defined benefit plans is
not reasonably estimable at this time.
JPMorgan Chase also has a number of defined benefit
pension plans not subject to Title IV of the
Employee Retirement Income Security Act. The most
significant of these plans is the Excess Retirement
Plan, pursuant to which certain employees earn pay
and interest credits on compensation amounts above
the maximum stipulated by law under a qualified
plan. The Excess Retirement Plan had an unfunded
projected benefit obligation in the amount of $273
million and $262 million, at December 31, 2008 and
2007, respectively.
Defined contribution plans
JPMorgan Chase offers several defined contribution
plans in the U.S. and in certain non-U.S.
locations, all of which are administered in
accordance with applicable local laws and
regulations. The most significant of these plans is
The JPMorgan Chase 401(k) Savings Plan (the “401(k)
Savings Plan”), which covers substantially all U.S.
employees. The 401(k) Savings Plan allows employees
to make pretax and Roth 401(k) contributions to
tax-deferred investment portfolios. The JPMorgan
Chase Common Stock Fund, which is an investment
option under the 401(k) Savings Plan, is a
nonleveraged employee stock ownership plan. The
Firm matches eligible employee contributions up to
a certain percentage of benefits-eligible
compensation per pay period, subject to plan and
legal limits. Employees begin to receive matching
contributions after completing a
one-year-of-service requirement and are immediately
vested in the Firm’s contributions when made.
Employees with total annual cash compensation of
$250,000 or more are not eligible for matching
contributions. The 401(k) Savings Plan also permits
discretionary profit-sharing contributions by
participating companies for certain employees,
subject to a specified vesting schedule.
OPEB plans
JPMorgan Chase offers postretirement medical and
life insurance benefits to certain retirees and
postretirement medical benefits to qualifying U.S.
employees. These benefits vary with length of
service and date of hire and provide for limits on
the Firm’s share of covered medical benefits. The
medical benefits are contributory, while the life
insurance benefits are noncontributory.
Postretirement medical benefits also are offered to
qualifying U.K. employees.
JPMorgan Chase’s U.S. OPEB obligation is funded
with corporate-owned life insurance (“COLI”)
purchased on the lives of eligible employees and
retirees. While the Firm owns the COLI policies,
COLI proceeds (death benefits, withdrawals and
other distributions) may be
used only to reimburse the Firm for its net
postretirement benefit claim payments and related
administrative expense. The U.K. OPEB plan is
unfunded.
The following table presents the changes in benefit obligations and plan assets and funded
status amounts reported on the Consolidated Balance Sheets for the Firm’s U.S. and non-U.S. defined
benefit pension and OPEB plans.
Defined benefit pension plans
As of or for the year ended December 31,
U.S.
Non-U.S.
OPEB plans(d)
(in millions)
2008
2007
2008
2007
2008
2007
Change in benefit obligation
Benefit obligation, beginning of year
$
(7,556
)
$
(8,098
)
$
(2,743
)
$
(2,917
)
$
(1,204
)
$
(1,443
)
Benefits earned during the year
(278
)
(270
)
(29
)
(36
)
(5
)
(7
)
Interest cost on benefit obligations
(488
)
(468
)
(142
)
(144
)
(74
)
(74
)
Plan amendments
—
—
—
2
—
—
Business combinations
—
—
—
—
(1
)(e)
—
Liabilities of newly material plans
—
—
—
(5
)
—
—
Employee contributions
NA
NA
(3
)
(3
)
(61
)
(57
)
Net gain (loss)
(147
)
494
214
327
99
231
Benefits paid
673
789
105
90
154
165
Expected Medicare Part D subsidy receipts
NA
NA
NA
NA
(10
)
(11
)
Curtailments
—
—
—
4
(6
)
(6
)
Settlements
—
—
—
24
—
—
Special termination benefits
—
—
(3
)
(1
)
—
(1
)
Foreign exchange impact and other
—
(3
)
594
(84
)
13
(1
)
Benefit obligation, end of year
$
(7,796
)
$
(7,556
)
$
(2,007
)
$
(2,743
)
$
(1,095
)
$
(1,204
)
Change in plan assets
Fair value of plan assets, beginning of year
$
9,960
$
9,955
$
2,933
$
2,813
$
1,406
$
1,351
Actual return on plan assets
(2,377
)
753
(298
)
57
(246
)
87
Firm contributions
38
37
88
92
3
3
Employee contributions
—
—
3
3
—
—
Assets of newly material plans
—
—
—
3
—
—
Benefits paid
(673
)
(789
)
(105
)
(90
)
(37
)
(35
)
Settlements
—
—
—
(24
)
—
—
Foreign exchange impact and other
—
4
(613
)
79
—
—
Fair value of plan assets, end of year
$
6,948
(c)
$
9,960
(c)
$
2,008
$
2,933
$
1,126
$
1,406
Funded (unfunded) status(a)(b)
$
(848
)
$
2,404
$
1
$
190
$
31
$
202
Accumulated benefit obligation, end of
year
$
(7,413
)
$
(7,184
)
$
(1,977
)
$
(2,708
)
NA
NA
(a)
Represents overfunded plans with an aggregate balance of $122 million and $3.3
billion at December 31, 2008 and 2007, respectively, and underfunded plans with an
aggregate balance of $938 million and $491 million at December 31, 2008 and 2007,
respectively.
(b)
The table above does not include any amounts attributable to the Washington Mutual
Pension and OPEB plans. The disposition of those plans has not been determined.
(c)
At December 31, 2008 and 2007, approximately $313 million and $299 million,
respectively, of U.S. plan assets included participation rights under participating
annuity contracts.
(d)
Includes an unfunded accumulated postretirement benefit obligation of $32 million
and $49 million at December 31, 2008 and
2007, respectively, for the U.K. plan.
(e)
Represents change resulting from the Bear Stearns merger.
The following table presents pretax pension and OPEB amounts recorded in AOCI.
Defined benefit pension plans
As of the year ended December 31,
U.S.
Non-U.S.
OPEB plans
(in millions)
2008
2007
2008
2007
2008
2007
Net loss
$
(3,493
)
$
(250
)
$
(492
)
$
(434
)
$
(349
)
$
(98
)
Prior service cost (credit)
(26
)
(31
)
2
2
40
58
Accumulated other comprehensive
income
(loss), pretax, end of year
The following table presents the components of net periodic benefit costs reported in the
Consolidated Statements of Income and other comprehensive income for the Firm’s U.S. and non-U.S.
defined benefit pension and OPEB plans.
Defined benefit pension plans
U.S.
Non-U.S.
OPEB plans
Year ended December 31, (in millions)
2008
2007
2006
2008
2007
2006
2008
2007
2006
Components of net periodic benefit cost
Benefits earned during the year
$
278
$
270
$
281
$
29
$
36
$
37
$
5
$
7
$
9
Interest cost on benefit obligations
488
468
452
142
144
120
74
74
78
Expected return on plan assets
(719
)
(714
)
(692
)
(152
)
(153
)
(122
)
(98
)
(93
)
(93
)
Amortization:
Net loss
—
—
12
25
55
45
—
14
29
Prior service cost (credit)
4
5
5
—
—
—
(16
)
(16
)
(19
)
Curtailment (gain) loss
1
—
2
—
—
1
4
2
2
Settlement (gain) loss
—
—
—
—
(1
)
4
—
—
—
Special termination benefits
—
—
—
3
1
1
—
1
2
Net periodic benefit cost
52
29
60
47
82
86
(31
)
(11
)
8
Other defined benefit pension plans(a)
11
4
2
14
27
36
NA
NA
NA
Total defined benefit plans
63
33
62
61
109
122
(31
)
(11
)
8
Total defined contribution plans
263
268
254
286
219
199
NA
NA
NA
Total pension and OPEB cost included in
compensation expense
$
326
$
301
$
316
$
347
$
328
$
321
$
(31
)
$
(11
)
$
8
Changes in plan assets and benefit
obligations recognized in other
comprehensive income
Net (gain) loss arising during the year
$
3,243
$
(533
)
NA
$
235
$
(176
)
NA
$
248
$
(223
)
NA
Prior service credit arising during the year
—
—
NA
—
(2
)
NA
—
—
NA
Amortization of net loss
—
—
NA
(27
)
(55
)
NA
—
(14
)
NA
Amortization of prior service (cost) credit
(5
)
(5
)
NA
—
—
NA
15
16
NA
Curtailment (gain) loss
—
—
NA
—
(5
)
NA
3
3
NA
Settlement loss
—
—
NA
—
1
NA
—
—
NA
Foreign exchange impact and other
—
—
NA
(150
)
—
NA
3
—
NA
Total recognized in other
comprehensive income
3,238
(538
)
NA
58
(237
)
NA
269
(218
)
NA
Total recognized in net periodic benefit cost
and other comprehensive income
$
3,290
$
(509
)
NA
$
105
$
(155
)
NA
$
238
$
(229
)
NA
(a)
Includes various defined benefit pension plans, which are individually immaterial.
The estimated pretax amounts that will be amortized from AOCI into net periodic benefit cost in
2009 are as follows.
Plan assumptions
JPMorgan Chase’s expected long-term rate of return
for U.S. defined benefit pension and OPEB plan
assets is a blended average of the investment
advisor’s projected long-term (10 years or more)
returns for the various asset classes, weighted by
the asset allocation. Returns on asset classes are
developed using a forward-looking building-block
approach and are not strictly based upon historical
returns. Equity returns are generally developed as
the sum of inflation, expected real earnings growth
and expected long-term dividend yield. Bond returns
are generally developed as the sum of inflation,
real bond yield and
risk spread (as appropriate), adjusted for the
expected effect on returns from changing yields.
Other asset-class returns are derived from their
relationship to the equity and bond markets.
Consideration was also given to current market
conditions and the short-term portfolio mix of
each Plan; as a result, the Firm has generally
maintained the same expected return on assets from
the prior year.
For the U.K. defined benefit pension plans, which
represent the most significant of the non-U.S.
defined benefit pension plans, procedures similar
to those in the U.S. are used to develop the
expected
long-term rate of return on defined benefit
pension plan assets, taking into consideration
local market conditions and the specific
allocation of plan assets. The expected long-term
rate of return on U.K. plan assets is an average
of projected long-term returns for each asset
class. The return on equities has been selected by
reference to the yield on long-term U.K.
government bonds plus an equity risk premium above
the risk-free rate. The return on “AA”-rated
long-term corporate bonds has been taken as the
average yield on such bonds, adjusted for the
expected downgrades and the expected narrowing of
credit spreads over the long term.
The discount rate used in determining the benefit
obligation under the U.S. defined benefit pension
and OPEB plans was selected by reference to the
yields on portfolios of bonds
with maturity dates
and coupons that closely match each of the plan’s
projected cash flows; such portfolios are derived
from a broad-based universe of high-quality
corporate bonds as of the measurement date. In
years in which these hypothetical bond portfolios
generate excess cash, such excess is assumed to be
reinvested at the one-year forward rates implied by
the Citigroup Pension Discount Curve published as
of the measurement date. The discount rate for the
U.K. defined benefit pension and OPEB plans
represents a rate implied from the yield curve of
the year-end iBoxx Ł corporate “AA” 15-year-plus
bond index (adjusted for expected downgrades in the
underlying bonds comprising the index) with a
duration corresponding to that of the underlying
benefit obligations.
The following tables present the
weighted-average annualized actuarial assumptions
for the projected and accumulated postretirement
benefit obligations and the components of net
periodic benefit costs for the Firm’s U.S. and
non-U.S. defined benefit pension and OPEB plans,
as of and for the periods indicated.
Weighted-average assumptions used to determine benefit obligations
The following table presents the effect of a
one-percentage-point change in the assumed health
care cost trend rate on JPMorgan Chase’s total
service and interest cost and accumulated
postretirement benefit obligation.
At December 31, 2008, the Firm increased the
discount rates used to determine its benefit
obligations for the U.S. defined benefit pension
and OPEB plans based upon current market interest
rates, which will result in a decrease in expense
of approximately $1.6 million for 2009. The 2009
expected long-term rate of return on U.S. pension
plan assets and U.S. OPEB plan assets remained at
7.5% and 7.0%, respectively. The health care
benefit obligation trend assumption declined from
9.25% in 2008 to 8.5% in 2009, declining to a rate
of 5% in 2014. As of December 31, 2008, the
interest crediting rate assumption and the assumed
rate of compensation increase remained at 5.25% and
4.0%, respectively.
JPMorgan Chase’s U.S. defined benefit pension and
OPEB plan expense is sensitive to the expected
long-term rate of return on plan assets and the
discount rate. With all other assumptions held
constant, a 25-basis point decline in the expected
long-term rate of return on U.S. plan assets would
result in an increase of approximately $23 million
in 2009 U.S. defined benefit pension and OPEB plan
expense. A 25-basis point decline in the discount
rate for the U.S. plans would result in an increase
in 2009 U.S. defined benefit pension and OPEB plan
expense of approximately $9 million and an increase
in the related projected benefit obligations of
approximately $159 million. A 25-basis point
decline in the discount rates for the non-U.S.
plans would result in an increase in the 2009
non-U.S. defined benefit pension and OPEB plan
expense of approximately $10 million. A 25-basis
point increase in the interest crediting rate for
the U.S. defined benefit pension plan would result
in an increase in 2009 U.S. defined benefit pension
expense of approximately $16 million and an
increase in the related projected benefit
obligations of approximately $66 million.
Investment strategy and asset allocation
The investment policy for the Firm’s postretirement
employee benefit plan assets is to optimize the
risk-return relationship as appropriate to the
respective plan’s needs and goals, using a global
portfolio of various asset classes diversified by
market segment, economic sector and issuer.
Specifically, the goal is to optimize the asset mix
for future benefit obligations, while managing
various risk factors and each plan’s investment
return objectives. For example, long-duration fixed
income securities are included in the U.S.
qualified pension plan’s asset allocation, in
recognition of its long-duration obligations. Plan
assets are managed by a combination of internal and
external investment managers and are rebalanced
within approved ranges on a continued basis. The
Firm reviews the allocation daily and all factors
that impact portfolio changes to ensure the Plan
stays within these ranges, rebalancing when deemed
necessary.
The Firm’s U.S. defined benefit pension plan assets
are held in trust and invested in a
well-diversified portfolio of equities (including
U.S. large and small capitalization
and international equities), fixed income
(including corporate and government bonds, Treasury
inflation-indexed and high-yield securities), real
estate, cash equivalents and alternative
investments. Non-U.S. defined benefit pension plan
assets are held in various trusts and similarly
invested in well-diversified portfolios of equity,
fixed income and other securities. Assets of the
Firm’s COLI policies, which are used to fund
partially the U.S. OPEB plan, are held in separate
accounts with an insurance company and are invested
in equity and fixed income index funds. As of
December 31, 2008, assets held by the Firm’s U.S.
and non-U.S. defined benefit pension and OPEB plans
do not include JPMorgan Chase common stock, except
in connection with investments in third-party
stock-index funds.
The following table presents the weighted-average asset allocation of the fair values of total plan
assets at December 31 for the years indicated, as well as the respective approved range/target
allocation by asset category, for the Firm’s U.S. and non-U.S. defined benefit pension and OPEB
plans.
Defined benefit pension plans
U.S.
Non-U.S.
OPEB plans(a)
Target
% of plan assets
Target
% of plan assets
Target
% of plan assets
December 31,
Allocation
2008
2007
Allocation
2008
2007
Allocation
2008
2007
Asset category
Debt securities
10-30
%
25
%
28
%
68
%
73
%
70
%
50
%
50
%
50
%
Equity securities
25-60
36
45
27
21
25
50
50
50
Real estate
5-20
7
9
1
1
1
—
—
—
Alternatives
15-50
32
18
4
5
4
—
—
—
Total
100
%
100
%
100
%
100
%
100
%
100
%
100
%
100
%
100
%
(a)
Represents the U.S. OPEB plan only, as the U.K. OPEB plan is unfunded.
Estimated future benefit payments
The following table presents benefit payments expected to be paid, which include the effect of
expected future service, for the years indicated. The OPEB medical and life insurance payments are
net of expected retiree contributions.
U.S.
Non-U.S.
Year ended December 31,
defined benefit
defined benefit
OPEB before
Medicare
(in millions)
pension plans
pension plans
Medicare Part D subsidy
Part D subsidy
2009
$
917
$
88
$
109
$
11
2010
928
94
111
12
2011
597
99
112
13
2012
616
102
110
14
2013
629
107
109
15
Years 2014–2018
3,333
571
513
87
Note 10 – Employee stock-based incentives
Effective January 1, 2006, the Firm adopted
SFAS 123R and all related interpretations using the
modified prospective transition method. SFAS 123R
requires all share-based payments to employees,
including employee stock options and stock
appreciation rights (“SARs”), to be measured at
their grant date fair values. The Firm also adopted
the transition election provided by FSP FAS
123(R)-3.
Upon adopting SFAS 123R, the Firm began to
recognize in the Consolidated Statements of Income
compensation expense for unvested stock options
previously accounted for under APB 25.
Additionally, JPMorgan Chase recognized as
compensation expense an immaterial cumulative
effect adjustment resulting from the SFAS 123R
requirement to estimate forfeitures at the grant
date instead of recognizing them as incurred.
Finally, the Firm revised its accounting policies
for share-based payments granted to employees
eligible for continued vesting under specific age
and service or service-related provisions
(“full-career eligible employees”) under SFAS 123R.
Prior to adopting SFAS 123R, the Firm’s accounting
policy for share-based payment awards granted to
full-career eligible employees was to recognize
compensation cost over the award’s stated service
period. Beginning with awards granted to
full-career eligible employees in 2006, JPMorgan
Chase recognized compensation expense on the grant
date without giving consideration to the impact of
post-employment restrictions. In the first quarter
of 2006, the Firm also began to accrue the
estimated cost of stock awards granted to
full-career eligible employees in the following
year.
In June 2007, the FASB ratified EITF 06-11, which
requires that realized tax benefits from dividends
or dividend equivalents paid on equity-classified
share-based payment awards that are charged to
retained earnings be recorded as an increase to
additional paid-in capital and included in the pool
of excess tax benefits available to
absorb tax deficiencies on share-based payment
awards. Prior to the issuance of EITF 06-11, the
Firm did not include these tax benefits as part of
this pool of excess tax benefits. The Firm adopted
EITF
06-11 on January 1, 2008. The adoption of this
consensus did not have an impact on the Firm’s
Consolidated Balance Sheets or results of
operations.
In connection with the Bear Stearns merger, 46
million Bear Stearns employee stock awards,
principally restricted stock units (“RSUs”),
capital appreciation plan units and stock options,
were exchanged for equivalent
JPMorgan Chase awards using the merger exchange
ratio of 0.21753. The fair value of these employee
stock awards was included in the purchase price
since substantially all of the awards were fully
vested immediately after the merger date under
provisions that provided for accelerated vesting
upon a change of control of Bear Stearns. However,
Bear Stearns vested employee stock options had no
impact on the purchase price; since the employee
stock options were significantly out of the money
at the merger date, the fair value of these awards
was equal to zero upon their conversion into
JPMorgan Chase options.
The Firm also exchanged 6 million shares of its
common stock for 27 million shares of Bear Stearns
common stock held in an irrevocable grantor trust
(the “RSU Trust”) using the merger exchange ratio
of 0.21753. The RSU Trust was established to hold
common stock underlying awards granted to selected
employees and key executives under certain Bear
Stearns employee stock plans. The RSU Trust was
consolidated on JPMorgan Chase’s Consolidated
Balance Sheets as of June 30, 2008, and the shares
held in the RSU Trust were recorded in “Shares held
in RSU Trust,” which reduced stockholders’ equity,
similar to the treatment for treasury stock. A
related obligation to issue stock under these
employee stock plans is reported in capital
surplus. The issuance of shares held in the RSU
Trust to employees will not have any effect on the
Firm’s total stockholders’ equity, net
income or earnings per share. Shares in the RSU
Trust were distributed in 2008 with approximately
half of the shares in the RSU Trust distributed in
January 2009. The remaining shares are expected to
be distributed over the next four years.
Employee stock-based awards
In 2008, 2007 and 2006, JPMorgan Chase granted
long-term stock-based awards to certain key
employees under the 2005 Long-Term Incentive Plan
(the “2005 Plan”). The 2005 Plan, plus prior Firm
plans and plans assumed as the result of
acquisitions, constitute the Firm’s stock-based
incentive plans (“LTI Plan”). The 2005 Plan became
effective on May 17, 2005, after approval by
shareholders at the 2005 annual meeting. In May
2008, the 2005 Plan was amended and under the terms
of the amended plan as of December 31, 2008, 348
million shares of common stock are available for
issuance through May 2013. The amended 2005 Plan is
the only active plan under which the Firm is
currently granting stock-based incentive awards.
RSUs are awarded at no cost to the recipient upon
their grant. RSUs are generally granted annually
and generally vest 50 percent after two years and
50 percent after three years and convert to shares
of common stock at the vesting date. In addition,
RSUs typically include
full-career eligibility provisions, which allow
employees to continue to vest upon voluntary
termination, subject to post-employment and other
restrictions. All of these awards are subject to
forfeiture until the vesting date. An RSU entitles
the recipient to receive cash payments equivalent
to any dividends paid on the underlying common
stock during the period the RSU is outstanding.
Under the LTI Plan, stock options and SARs have
been granted with an exercise price equal to the
fair value of JPMorgan Chase’s common stock on the
grant date. The Firm typically awards SARs to
certain key employees once per year, and it also
periodically grants discretionary stock-based
incentive awards to individual employees, primarily
in the form of both employee stock options and
SARs. The 2008 and 2007 grants of SARs to key
employees vest ratably over five years (i.e., 20%
per year) and the 2006 awards vest one-third after
each of years three, four, and five. These awards
do not include any full-career eligibility
provisions and all awards generally expire ten
years after the grant date.
The Firm separately recognizes compensation expense
for each tranche of each award as if it were a
separate award with its own vesting date. For each
tranche granted (other than grants to employees who
are full-career eligible at the grant date),
compensation expense is recognized on a
straight-line basis from the grant date until the
vesting date of the respective tranche, provided
that the employees will not become full-career
eligible during the vesting period. For each
tranche granted to employees who will become
full-career eligible during the vesting period,
compensation expense is recognized on a
straight-line basis from the grant date until the
earlier of the employee’s full-career eligibility
date or the vesting date of the respective tranche.
The Firm’s policy for issuing shares upon
settlement of employee stock-based incentive awards
is to issue either new shares of common stock or
treasury shares. During 2008 and 2007, the Firm
settled all of its employee stock-based awards by
issuing treasury shares. During 2006, the Firm
settled all of its employee stock-based awards by
issuing new shares of common stock from January 1
through May 31, 2006, and by issuing treasury
shares thereafter.
In January 2008, the Firm awarded to its Chairman
and Chief Executive Officer up to two million SARs.
The terms of this award are distinct from, and more
restrictive than, other equity grants regularly
awarded by the Firm. The SARs, which have a
ten-year term, will become exercisable no earlier
than January 22, 2013, and have an exercise price
of $39.83, the price of JPMorgan Chase common stock
on the date of the award. The number of SARs that
will become exercisable (ranging from none to the
full two million) and their exercise date or dates
may be determined by the Board of Directors based
on an assessment of the performance of both the CEO
and JPMorgan Chase. That assessment will be made by
the Board in the year prior to the fifth
anniversary of the date of the award, relying on
such factors that in its sole discretion the Board
deems
appropriate. Due to the substantial uncertainty
surrounding the number of SARs that will ultimately
be granted and their exercise dates, a grant date
has not been established for accounting purposes.
However, since the service inception date precedes
the grant date, the Firm will recognize this award
ratably over an assumed five-year service period,
subject to a requirement to recognize changes in
the fair value of the award through the grant date.
The Firm recognized $1 million in compensation
expense in 2008 for this award.
RSU activity
Compensation expense for RSUs is measured based
upon the number of shares granted multiplied by
the stock price at the grant date and is
recognized in net income as previously described.
The following table summarizes JPMorgan Chase’s
RSU activity for 2008.
The total fair value of shares that vested
during the years ended December 31, 2008, 2007
and 2006, was $1.6 billion, $1.5 billion and $1.3
billion, respectively.
Compensation expense, which is measured at the grant date as the fair value of employee stock
options and SARs, is recognized in net income as described above.
The following table summarizes JPMorgan Chase’s employee stock option and SARs activity for the
year ended December 31, 2008, including awards granted to key employees and awards granted in prior
years under broad-based plans.
The weighted-average grant date per share fair
value of stock options and SARs granted during the
years ended December 31, 2008, 2007 and 2006, was
$10.36, $13.38 and $10.99, respectively. The total
intrinsic value of options exercised during the
years ended December 31, 2008, 2007 and 2006 was
$391 million, $937 million and $994 million,
respectively.
Impact of adoption of SFAS 123R
During 2006, the incremental expense related to the
Firm’s adoption of SFAS 123R was $712 million. This
amount represents an accelerated noncash
recognition of costs that would otherwise have been
incurred in future periods. Also, as a result of
adopting SFAS 123R, the Firm’s income from
continuing operations (pretax) for the year ended
December 31, 2006, was lower by $712 million, and
each of income from continuing operations
(after-tax) and net income for the year ended
December 31, 2006, was lower by $442 million, than
if the Firm had continued to account for
stock-based incentives under APB 25 and SFAS 123.
Basic and diluted earnings per share from
continuing operations, as well as basic and diluted
net income per share, for the year ended December31, 2006 were $.13 and $.12 lower, respectively,
than if the Firm had not adopted SFAS 123R.
Compensation expense
The Firm recognized noncash compensation expense
related to its various employee stock-based
incentive awards of $2.6 billion, $2.0 billion and
$2.4 billion (including the $712 million
incremental impact of adopting SFAS 123R) for the
years ended December 31, 2008, 2007, and 2006,
respectively, in its Consolidated Statements of
Income. These amounts included an accrual for the
estimated cost of stock awards to be granted to
full-career eligible employees of $409 million,
$500 million and $498 million for the years ended
December 31, 2008, 2007 and 2006, respectively. At
December 31, 2008, approximately $1.9 billion
(pretax) of compensation cost related to unvested
awards has not yet been charged to net income. That
cost is expected to be amortized into compensation
expense over a weighted-average period of 1.3
years. The Firm does not capitalize any
compensation cost related to share-based
compensation awards to employees.
Cash flows and tax benefits
The total income tax benefit related to
stock-based incentive arrangements recognized in
the Firm’s Consolidated Statements of Income for
the years ended December 31, 2008, 2007 and 2006,
was $1.1 billion, $810 million and $947 million,
respectively.
The following table sets forth the cash received
from the exercise of stock options under all
stock-based incentive arrangements and the actual
tax benefit realized related to the tax deduction
from the exercise of stock options.
Year ended December 31, (in millions)
2008
2007
2006
Cash received for options exercised
$
1,026
$
2,023
$
1,924
Tax benefit realized
72
238
211
Valuation assumptions
The following table presents the assumptions used
to value employee stock options and SARs granted
during the period under the Black-Scholes
valuation model.
Prior to the adoption of SFAS 123R, the Firm
used the historical volatility of its common stock
price as the expected volatility assumption in
valuing options. The Firm completed a review of its
expected volatility assumption in 2006. Effective
October 1, 2006, JPMorgan Chase began to value its
employee stock options granted or modified after
that date using an expected volatility assumption
derived from the implied volatility of its publicly
traded stock options.
The expected life assumption is an estimate of the
length of time that an employee might hold an
option or SAR before it is exercised or canceled.
The expected life assumption was developed using
historic experience.
Note 11 – Noninterest expense
Merger costs
Costs associated with the Bear Stearns merger and
the Washington Mutual transaction in 2008, the 2004
merger with Bank One Corporation, and The Bank of
New York, Inc. (“The Bank of New York”) transaction
in 2006 are reflected in the merger costs caption
of the Consolidated Statements of Income. For a
further discussion of the Bear Stearns merger and
the Washington Mutual transaction, see Note 2 on
pages 123–128 of this Annual Report. A summary of
merger-related costs is shown in the following
table.
2008
Year ended December 31, (in millions)
Bear Stearns
Washington Mutual
Total
2007(b)
2006(b)
Expense category
Compensation
$
181
$
113
$
294
$
(19
)
$
26
Occupancy
42
—
42
17
25
Technology and communications and other
85
11
96
188
239
The Bank of New York transaction
—
—
—
23
15
Total(a)
$
308
$
124
$
432
$
209
$
305
(a)
With the exception of occupancy and technology-related write-offs, all of the costs in
the table required the expenditure of cash.
(b)
The 2007 and 2006 activity reflect the 2004 merger with Bank One Corporation and the
Bank of New York transaction.
The table below shows the change in the merger reserve balance related to the costs associated
with the transactions.
2008
Year ended December 31, (in millions)
Bear Stearns
Washington Mutual
Total
2007(a)
2006(a)
Merger reserve balance, beginning of period
$
—
$
—
$
—
$
155
$
311
Recorded as merger costs
308
124
432
186
290
Included in net assets acquired
1,112
435
1,547
(60
)
—
Utilization of merger reserve
(1,093
)
(118
)
(1,211
)
(281
)
(446
)
Merger reserve balance, end of period
$
327
$
441
$
768
$
—
(b)
$
155
(b)
(a)
The 2007 and 2006 activity reflect the 2004 merger with Bank One Corporation.
(b)
Excludes $10 million and $21 million at December 31, 2007 and 2006, respectively,
related to the Bank of New York transaction.
Note 12 – Securities
Securities are classified as AFS,
held-to-maturity (“HTM”) or trading. Trading
securities are discussed in Note 6 on pages
146–148 of this Annual Report. Securities are
classified primarily as AFS when used to manage the
Firm’s exposure to interest rate movements, as well
as to make strategic longer-term investments. AFS
securities are carried at fair value on the
Consolidated Balance Sheets. Unrealized gains and
losses, after any applicable SFAS 133 hedge
accounting adjustments, are reported as net
increases or decreases to accumulated other
comprehensive income (loss). The specific
identification method is used to determine realized
gains and losses on AFS securities, which are
included in securities gains (losses) on the
Consolidated Statements of Income. Securities that
the Firm has the positive intent and ability to
hold to maturity are classified as HTM and are
carried at amortized cost on the Consolidated
Balance Sheets. The Firm has not classified new
purchases of securities as HTM for the past several
years.
The following table presents realized gains and
losses from AFS securities.
Year ended December 31,
(in millions)
2008
2007
2006
Realized gains
$
1,890
$
667
$
399
Realized losses
(330
)(b)
(503
)
(942
)
Net realized securities
gains (losses)(a)
$
1,560
$
164
$
(543
)
(a)
Proceeds from securities sold were within approximately 2% of amortized cost.
(b)
2008 includes $76 million of losses due to the other-than-temporary impairment of
subprime mortgage-backed securities.
AFS securities in unrealized loss positions are
analyzed in depth as part of the Firm’s ongoing
assessment of other-than-temporary impairment.
Potential other-than-temporary impairment of AFS
securities is considered using a variety of
factors, including the length of time and extent to
which the market value has been less than cost; the
financial condition and near-term prospects of the
issuer or underlying collateral of a security; and
the Firm’s intent and ability to retain the
security in order to allow for an anticipated
recovery in fair value. Where applicable under EITF
Issue 99-20, the Firm estimates the cash flows over
the life of the security to determine if any
adverse changes have occurred that require an
other-than-temporary impairment charge. The Firm
applies EITF Issue 99-20 to beneficial interests in
securitizations that are rated below “AA” at
acquisition or that can be contractually prepaid or
otherwise settled in such a way that the Firm would
not recover substantially all of its recorded
investment. The Firm considers a decline in fair
value to be other-than-temporary if it is probable
that the Firm will not recover its recorded
investment, including as applicable under EITF
Issue 99-20, when an adverse change in cash flows
has occurred.
The Firm’s analysis of the financial condition and
near term prospects of the issuer or underlying
collateral of a security noted above includes
analysis of performance indicators relevant to the
specific investment. For asset-backed investments,
such relevant performance indicators may include
ratings, valuation of subordinated positions in
current and/or stress scenarios, excess spread or
overcollateralization
levels, and whether certain protective triggers
have been reached. For mortgage-backed investments,
such relevant performance indicators may include
ratings, prepayment speeds, delinquencies, default
rates, loss severities, geographic concentration,
and forecasted performance under various home price
decline stress scenarios.
As of December 31, 2008, approximately $438 million
of the unrealized losses relate to securities that
have been in an unrealized loss position for longer
than 12 months, and primarily relate to prime
mortgage-backed securities and credit card-related
asset-backed securities. The prime mortgage-backed
securities are primarily rated “AAA”, while the
credit card-related asset-backed securities are rated “BBB”. Based upon the
analyses described above, which have been applied
to these securities, the Firm believes that the
unrealized losses result from liquidity conditions
in the current market environment and not from
concerns regarding the credit of the issuers or
underlying collateral. The Firm does not believe it
is probable that it will not recover its
investments, given the current levels of collateral
and credit enhancements that exist to protect the
investments. For securities analyzed for impairment
under EITF 99-20, the collateral and credit
enhancement features are at levels sufficient to
ensure that an adverse change in expected future
cash flows has not occurred.
As of December 31, 2008, approximately $6.2
billion of the unrealized losses relate to
securities that have been in an unrealized loss
position for less than 12 months; these losses
largely relate to credit
card-related asset-backed securities, mortgage-backed securities issued by private issuers and commercial and industrial asset-backed securities. Of the $2.0 billion of
unrealized losses related to credit card-related
asset-backed securities, $1.7 billion relates to
purchased credit card-related asset-backed
securities, and $304 million relates to retained
interests in the Firm’s own credit card receivable
securitizations. The credit card-related
asset-backed securities include “AAA”, “A” and
“BBB” ratings. Based on the levels of excess spread
available to absorb credit losses, and
based on the value of interests subordinate to the
Firm’s interests where applicable, the Firm does
not believe it is probable that it will not recover
its investments. Where applicable under EITF 99-20,
the collateral and credit enhancement features are
at levels sufficient to ensure that an adverse
change in expected future cash flows has not
occurred. Of the remaining unrealized losses as of
December 31, 2008, related to securities that have
been in an unrealized loss position for less than
12 months, $2.7 billion relates to
mortgage-backed securities issued by private
issuers and $820 million relates to commercial and industrial asset-backed securities. The mortgage-backed securities and commercial and industrial asset-backed securities are
predominantly rated “AAA”. Based on an analysis of
the performance indicators noted above for
mortgage-backed securities and asset-backed securities, which have been applied
to the loans underlying these securities, the Firm does not believe
it is probable that it will not recover its
investments in these securities.
The Firm intends to hold the securities in an
unrealized loss position for a period of time sufficient to
allow for an anticipated recovery in fair value or
maturity. The Firm has sufficient capital and
liquidity to hold these securities until recovery
in fair value or maturity. Based on the Firm’s
evaluation of the factors and other objective
evidence described above, the Firm believes that
the securities are not other-than-temporarily
impaired as of December 31, 2008.
The following table presents the amortized cost, estimated fair value and average yield at December31, 2008, of JPMorgan Chase’s AFS and HTM securities by contractual maturity.
Includes securities with no stated maturity. Substantially all of the Firm’s
mortgage-backed securities and collateralized mortgage obligations are due in ten years or
more based upon contractual maturity. The estimated duration, which reflects anticipated
future prepayments based upon a consensus of dealers in the market, is approximately four
years for mortgage-backed securities and collateralized mortgage obligations.
(b)
The average yield is based upon amortized cost balances at year-end. Yields are
derived by dividing interest income by total amortized cost. Taxable-equivalent yields are
used where applicable.
Note 13
– Securities financing activities
JPMorgan Chase enters into resale agreements,
repurchase agreements, securities borrowed
transactions and securities loaned transactions,
primarily to finance the Firm’s inventory
positions, acquire securities to cover short
positions and settle other securities obligations.
The Firm also enters into these transactions to
accommodate customers’ needs.
Resale agreements and repurchase agreements are
generally treated as collateralized financing
transactions carried on the Consolidated Balance
Sheets at the amounts the securities will be
subsequently sold or repurchased, plus accrued
interest. On January 1, 2007, pursuant to the
adoption of SFAS 159, the Firm elected fair value
measurement for certain resale and repurchase
agreements. In 2008, the Firm elected fair value
measurement for certain newly transacted securities
borrowed and securities lending agreements. For a
further discussion of SFAS 159, see Note 5 on pages
144–146 of this Annual Report. The securities
financing agreements for which the fair value
option was elected continue to be reported within
securities purchased under resale agreements;
securities loaned or sold under repurchase
agreements; securities borrowed; and other borrowed
funds on the Consolidated Balance Sheets.
Generally, for agreements
carried at fair value, current-period interest
accruals are recorded within interest income and
interest expense, with changes in fair value
reported in principal transactions revenue.
However, for financial instruments containing
embedded derivatives that would be separately
accounted for in accordance with SFAS 133, all
changes in fair value, including any interest
elements, are reported in principal transactions
revenue. Where appropriate, resale and repurchase
agreements with the same counterparty are reported
on a net basis in accordance with FIN 41. JPMorgan
Chase takes possession of securities purchased
under resale agreements. On a daily basis, JPMorgan
Chase monitors the market value of the underlying
collateral, primarily U.S. and non-U.S. government
and agency securities, that it has received from
its counterparties, and requests additional
collateral when necessary.
Transactions similar to financing activities that
do not meet the SFAS 140 definition of a repurchase
agreement are accounted for as “buys” and “sells”
rather than financing transactions. These
transactions are accounted for as a purchase (sale)
of the underlying securities with a forward
obligation to sell (purchase) the securities. The
forward purchase (sale) obligation, a derivative,
is recorded on the Consolidated Balance
Sheets at its fair value, with changes in fair
value recorded in principal transactions revenue.
Securities borrowed and securities lent are
recorded at the amount of cash collateral advanced
or received. Securities borrowed consist primarily
of government and equity securities. JPMorgan Chase
monitors the market value of the securities
borrowed and lent on a daily basis and calls for
additional collateral when appropriate. Fees
received or paid in connection with securities
borrowed and lent are recorded in interest income
or interest expense.
The following table details the components of collateralized financings.
December 31, (in millions)
2008
2007
Securities purchased under resale agreements(a)
$
200,265
$
169,305
Securities borrowed(b)
124,000
84,184
Securities sold under repurchase agreements(c)
$
174,456
$
126,098
Securities loaned
6,077
10,922
(a)
Includes resale agreements of $20.8 billion and $19.1 billion accounted for at
fair value at December 31, 2008 and 2007, respectively.
(b)
Includes securities borrowed of $3.4 billion accounted for at fair value at
December 31, 2008.
(c)
Includes repurchase agreements of $3.0 billion and $5.8 billion accounted for at
fair value at December 31, 2008 and 2007, respectively.
JPMorgan Chase pledges certain financial
instruments it owns to collateralize repurchase
agreements and other securities financings. Pledged
securities that can be sold or repledged by the
secured party are identified as financial
instruments owned (pledged to various parties) on
the Consolidated Balance Sheets.
At December 31, 2008, the Firm received securities
as collateral that could be repledged, delivered or
otherwise used with a fair value of approximately
$511.9 billion. This collateral was generally
obtained under resale or securities borrowing
agreements. Of these securities, approximately
$456.6 billion were repledged, delivered or
otherwise used, generally as collateral under
repurchase agreements, securities lending
agreements or to cover short sales.
Note
14 – Loans
The accounting for a loan may differ based upon
whether it is originated or purchased and as to
whether the loan is used in an investing or trading
strategy. For purchased loans held-for-investment,
the accounting also differs depending on whether a
loan is credit-impaired at the date of acquisition.
Purchased loans with evidence of credit
deterioration since the origination date and for
which it is probable, at acquisition, that all
contractually required payments receivable will not
be collected are considered to be credit-impaired.
The measurement framework for loans in the
Consolidated Financial Statements is one of the
following:
•
At the principal amount outstanding, net of the allowance for loan losses, unearned
income and any net deferred loan fees or costs, for loans held for investment (other than
purchased credit-impaired loans);
•
At the lower of cost or fair value, with valuation changes recorded in noninterest
revenue, for loans that are classified as held-for-sale; or
•
At fair value, with changes in fair value recorded in noninterest revenue, for loans
classified as trading assets or risk managed on a fair value basis;
•
Purchased credit-impaired loans held for investment are accounted for under SOP
03-3 and initially measured at fair value, which includes estimated future credit losses.
Accordingly, an allowance for loan losses related to these loans is not recorded at the
acquisition date.
See Note 5
on pages 144–146 of this Annual Report
for further information on the Firm’s elections of
fair value accounting under SFAS 159. See Note 6
on pages 146–148 of this Annual Report for
further information on loans carried at fair value
and classified as trading assets.
For loans held for investment, other than purchased
credit-impaired loans, interest income is
recognized using the interest method or on a basis
approximating a level rate of return over the term
of the loan.
Loans within the held-for-investment portfolio that
management decides to sell are transferred to the
held-for-sale portfolio. Transfers to held-for-sale
are recorded at the lower of cost or fair value on
the date of transfer. Credit-related losses are
charged off to the allowance for loan losses and
losses due to changes in interest rates, or
exchange rates, are recognized in noninterest
revenue.
Loans within the held-for-sale portfolio that
management decides to retain are transferred to the
held-for-investment portfolio at the lower of cost
or fair value. These loans are subsequently
assessed for impairment based on the Firm’s
allowance methodology. For a further discussion of
the methodologies used in establishing the Firm’s
allowance for loan losses, see Note 15 on pages
166–168 of this Annual Report.
Nonaccrual loans are those on which the accrual of
interest is discontinued. Loans (other than certain
consumer and purchased credit-impaired loans
discussed below) are placed on nonaccrual status
immediately if, in the opinion of management, full
payment of principal or interest is in doubt, or
when principal or interest is 90 days or more past
due and collateral, if any, is insufficient to
cover principal and interest. Loans are charged off
to the allowance for loan losses when it is highly
certain that a loss has been realized. Interest
accrued but not collected at the date a loan is
placed on nonaccrual status is reversed against
interest income. In addition, the amortization of
net deferred loan fees is suspended. Interest
income on nonaccrual loans is recognized only to
the extent it is received in cash. However, where
there is doubt regarding the ultimate
collectibility of loan principal, all cash
thereafter received is applied to reduce the
carrying value of such loans (i.e., the cost
recovery method). Loans are restored to accrual
status only when future
payments of interest and principal are reasonably
assured.
Consumer loans, other than purchased
credit-impaired loans, are generally charged to
the allowance for loan losses upon reaching
specified stages of delinquency, in accordance
with the Federal Financial Institutions
Examination Council policy. For example, credit
card loans are charged off by the end of the month
in which the account becomes 180 days past due or
within 60 days from receiving notification of the
filing of bankruptcy, whichever is earlier.
Residential mortgage products are generally
charged off to net realizable value at no later
than 180 days
past due. Other consumer
products, if collateralized, are generally
charged off to net realizable value at 120 days
past due. Accrued interest on residential mortgage
products, automobile financings, student loans and
certain other consumer loans are accounted for in
accordance with the nonaccrual loan policy
discussed in the preceding paragraph. Interest and
fees related to credit card loans continue to
accrue until the loan is charged off or paid in
full. Accrued interest on all other consumer loans
is generally reversed against interest income when
the loan is charged off. A collateralized loan is
reclassified to assets acquired in loan
satisfactions, within other assets, only when
JPMorgan Chase has taken physical possession of the
collateral, regardless of whether formal
foreclosure proceedings have taken place.
For purchased credit-impaired loans, the excess of
the loan’s cash flows expected to be collected over
the initial fair value (i.e., the accretable yield)
is accreted into interest income at a level rate of
return over the term of the loan, provided that the
timing and amount of future cash flows is
reasonably estimable. On a periodic basis, the Firm
updates the amount of cash flows expected to be
collected for these loans, incorporating
assumptions regarding default rates, loss
severities, the amounts and timing of prepayments
and other factors that are reflective of current
market conditions. Probable and significant
increases in cash flows previously expected to be
collected would first be used to reverse any
related valuation allowance; any remaining
increases are recognized prospectively as interest
income. Probable decreases in expected cash flows
after the acquisition date, excluding decreases
related to repricings of variable rate loans, are
recognized through the allowance for loan losses.
Disposals of loans, which may include sales of
loans, receipt of payments in full by the borrower,
or foreclosure, result in removal of the loan from
the SOP
03-3 portfolio.
With respect to purchased credit-impaired loans,
when
the timing and/or amounts of expected cash flows on
such loans are not reasonably estimable, no
interest is accreted and the loan is reported as a
nonperforming loan; otherwise, if the timing and
amounts of expected cash flows for purchased
credit-impaired loans are reasonably estimable,
then interest is accreted and the loans are
reported as performing loans.
The composition of the Firm’s aggregate loan
portfolio at each of the dates indicated was as
follows.
December 31, (in millions)
2008
2007
U.S. wholesale loans:
Commercial and industrial
$
68,709
$
55,655
Real estate
64,214
16,748
Financial institutions
20,615
14,757
Government agencies
5,918
5,770
Other
22,330
25,883
Loans held-for-sale and at fair value
4,990
14,440
Total U.S. wholesale loans
186,776
133,253
Non-U.S. wholesale loans:
Commercial and industrial
27,941
27,659
Real estate
2,667
3,527
Financial institutions
16,381
16,740
Government agencies
603
720
Other
18,711
21,968
Loans held-for-sale and at fair value
8,965
9,209
Total non-U.S. wholesale loans
75,268
79,823
Total wholesale loans:(a)(b)
Commercial and industrial
96,650
83,314
Real estate(c)
66,881
20,275
Financial institutions
36,996
31,497
Government agencies
6,521
6,490
Other
41,041
47,851
Loans held-for-sale and at fair value(d)
13,955
23,649
Total wholesale loans
262,044
213,076
Total consumer loans:(e)
Home equity
114,335
94,832
Prime mortgage
72,266
39,988
Subprime mortgage
15,330
15,473
Option ARMs
9,018
—
Auto loans
42,603
42,350
Credit card(f)
104,746
84,352
Other
33,715
25,314
Loans held-for-sale(g)
2,028
3,989
Total
consumer loans – excluding
purchased credit-impaired
394,041
306,298
Consumer
loans – purchased credit-impaired
88,813
NA
Total consumer loans
482,854
306,298
Total
loans(b)(h)
$
744,898
$
519,374
(a)
Includes Investment Bank, Commercial Banking, Treasury & Securities Services and
Asset Management.
(b)
Includes purchased credit-impaired loans of $224 million at December 31, 2008,
acquired in the Washington Mutual transaction.
(c)
Represents credits extended for real estate-related purposes to borrowers who are
primarily in the real estate development or investment businesses and which the repayment
is predominantly from the sale, lease, management, operations or refinancing of the
property.
(d)
Includes loans for commercial & industrial, real estate, financial institutions
and other of $11.0 billion, $428 million, $1.5 billion and $995 million at December 31,2008, respectively, and $19.6 billion, $548 million, $862 million and $2.7 billion at
December 31, 2007 respectively.
(e)
Includes Retail Financial Services, Card Services and the Corporate/Private Equity
segment.
(f)
Includes billed finance charges and fees net of an allowance for uncollectible
amounts.
(g)
Includes loans for prime mortgage and other (largely student loans) of $206
million and $1.8 billion at December 31, 2008, respectively, and $570 million and $3.4
billion at December 31, 2007, respectively.
(h)
Loans (other than purchased loans and those for which the SFAS 159 fair value
option has been elected) are presented net of unearned income and net deferred loan fees
of $694 million and $1.0 billion at December 31, 2008 and 2007, respectively.
The following table reflects information about the Firm’s loan sales.
Year ended December 31, (in millions)
2008
2007
2006
Net gains/(losses) on sales of loans (including
lower of cost or fair value adjustments)(a)
$
(2,508
)
$
99
$
672
(a)
Excludes sales related to loans accounted for at fair value.
Purchased credit-impaired loans
In connection with the Washington Mutual
transaction, JPMorgan Chase acquired certain loans
that it deemed to be credit-impaired under SOP
03-3. Wholesale loans with a carrying amount of
$224 million at December 31, 2008, were determined
to be credit-impaired at the date of acquisition in
accordance with SFAS 114. These wholesale loans are
being accounted for individually (not on a pooled
basis) and are reported as nonperforming loans
since cash flows for each individual loan are not
reasonably estimable. Such loans are excluded from
the remainder of the following discussion, which
relates solely to purchased credit-impaired
consumer loans.
Purchased credit-impaired consumer loans were
determined to be credit-impaired based upon
specific risk characteristics of the loan,
including product type, loan-to-value ratios, FICO
scores, and past due status. SOP 03-3 allows
purchasers to aggregate credit-impaired loans
acquired in the same fiscal quarter into one or
more pools, provided that the loans have common
risk characteristics. A pool is then accounted for
as a single asset with a single composite interest
rate and an aggregate expectation of cash flows.
With respect to the Washington Mutual transaction,
all of the consumer loans were aggregated into
pools of loans with common risk characteristics.
The table below sets forth information about
these purchased credit-impaired consumer loans
at the acquisition date.
The amounts in the table above were revised in the fourth quarter of 2008 due to
the Firm’s refinement of both estimates and its application of certain provisions of SOP
03-3.
(c)
Represents undiscounted principal and interest cash flows expected at acquisition.
(d)
This amount is recognized into interest income over the estimated life of the
underlying loans.
The Firm determined the fair value of the
purchased credit-impaired consumer loans by
discounting the cash flows expected to be collected
at a market observable discount rate, when available, adjusted for
factors that a market participant would consider in
determining fair value. In determining the cash
flows expected to be collected, management
incorporated assumptions regarding default rates,
loss severities and the amounts and timing of
prepayments. Contractually required payments were
determined following the same process used to
estimate cash flows expected to be collected, but
without incorporating assumptions related to
default rates and loss severities.
Purchased credit-impaired loans acquired in the
Washington Mutual transaction are reported in loans
on the Firm’s Consolidated Balance Sheets.
Following the initial acquisition date of these
loans, the allowance for loan losses, if any is
required, would be reported as a reduction of the
carrying amount of the loans. No allowance has been
recorded for these loans as of December 31, 2008.
The outstanding balance and the carrying value of
the purchased credit-impaired consumer loans were
as follows.
December 31, (in millions)
2008
Outstanding balance(a)
$
118,180
Carrying amount
88,813
(a)
Represents the sum of principal and earned interest at the reporting date.
Interest income is being accreted on the
purchased credit-impaired consumer loans based on
the Firm’s belief that both the timing and amount
of cash flows expected to be collected is
reasonably estimable. For variable rate loans,
expected future cash flows are based on the current
contractual rate of the underlying loans.
The table
below sets forth the accretable yield activity for
these loans for the year ended December 31, 2008.
A loan is considered impaired when, based upon
current information and events, it is probable that
the Firm will be unable to collect all amounts due
(including principal and interest) according to the
contractual terms of the loan agreement. Impaired
loans include certain nonaccrual wholesale loans
and loans for which a charge-off has been recorded
based upon the fair value of the underlying
collateral. Impaired loans also include loans that
have been modified in troubled debt restructurings
as a concession to borrowers experiencing financial
difficulties. Troubled debt restructurings
typically result from the Firm’s loss mitigation
activities and could include rate reductions,
principal forgiveness, forbearance and other
actions intended to minimize the economic loss and
to avoid foreclosure or repossession of collateral.
When the Firm modifies home equity lines of credit
in troubled debt restructurings, future lending
commitments related to the modified loans are
canceled as part of the terms of the modification.
Accordingly, the Firm does not have future
commitments to lend additional funds related to
these modified loans. Purchased credit-impaired
loans are not required to be reported as impaired
loans as long as it is probable that the Firm
expects to collect all cash flows expected at
acquisition, plus additional cash flows expected to
be collected arising from changes in estimates
after acquisition.
Accordingly, none of the credit-impaired loans
acquired in the Washington Mutual transaction are
reported in the following tables.
Interest income
on impaired loans is recognized based on the Firm’s
policy for recognizing interest on accrual and
nonaccrual loans. Certain loans that have been
modified through troubled debt restructurings
accrue interest under this policy.
The tables below set forth information about JPMorgan Chase’s impaired loans, excluding credit
card loans which are discussed below. The Firm primarily uses the discounted cash flow method for
valuing impaired loans.
December 31, (in millions)
2008
2007
Impaired loans with an allowance:
Wholesale
$
2,026
$
429
Consumer(a)
2,252
322
Total impaired loans with an allowance(b)
4,278
751
Impaired loans without an allowance:(c)
Wholesale
62
28
Consumer(a)
—
—
Total impaired loans without an allowance
62
28
Total impaired loans(b)
$
4,340
$
779
Allowance for impaired loans under SFAS 114:
Wholesale
$
712
$
108
Consumer(a)
379
116
Total allowance for impaired loans under
SFAS 114(d)
$
1,091
$
224
Year ended December 31, (in millions)
2008
2007
2006
Average balance of impaired loans
during the period:
Wholesale
$
896
$
316
$
697
Consumer(a)
1,211
317
300
Total impaired loans(b)
$
2,107
$
633
$
997
Interest income recognized on impaired
loans during the period:
Wholesale
$
—
$
—
$
2
Consumer(a)
57
—
—
Total interest income recognized on
impaired loans during the period
$
57
$
—
$
2
(a)
Excludes credit card loans.
(b)
In 2008, methodologies for calculating impaired loans have changed. Prior periods
have been revised to conform to current presentation.
(c)
When the discounted cash flows, collateral value or market price equals or exceeds
the carrying value of the loan, then the loan does not require an allowance under SFAS
114.
(d)
The allowance for impaired loans under SFAS 114 is included in JPMorgan Chase’s
allowance for loan losses. The allowance for certain consumer impaired loans has been
categorized in the allowance for loan losses as formula-based.
During 2008, loss mitigation efforts related to delinquent mortgage and home equity loans
increased substantially, resulting in a significant increase in consumer troubled debt
restructurings. In the fourth quarter of 2008, the Firm announced plans to further expand loss
mitigation efforts related to these portfolios, including plans to open regional counseling
centers, hire additional loan counselors, introduce new financing alternatives, proactively reach
out to borrowers to offer pre-qualified modifications, and commence a new process to independently
review each loan before moving it into the foreclosure process. These loss mitigation efforts,
which generally represent various forms of term extensions, rate reductions
and forbearances, are expected to result in additional increases in the balance of modified loans
carried on the Firm’s balance sheet, including loans accounted for as troubled debt restructurings,
while minimizing the economic loss to the Firm and providing alternatives to foreclosure.
JPMorgan Chase may modify the terms of its credit card loan agreements with borrowers who have
experienced financial difficulty. Such modifications may include canceling the customer’s available
line of credit on the credit card, reducing the interest rate on the card, and placing the customer
on a fixed payment plan not exceeding 60 months. If the cardholder does not comply with the
modified terms, then the credit card loan agreement will revert back to its original terms, with
the amount of any loan outstanding reflected in the appropriate delinquency “bucket” and the loan
amounts then charged-off in accordance with the Firm’s standard charge-off policy. Under these
procedures, $2.4 billion and $1.4 billion of on-balance sheet credit card loan outstandings have
been modified at December 31, 2008 and 2007, respectively. In accordance with the Firm’s
methodology for determining its consumer allowance for loan losses, the Firm had already
provisioned for these credit card loans; the modifications to these credit card loans had no
incremental impact on the Firm’s allowance for loan losses.
Note
15 – Allowance for credit losses
During 2008, in connection with the Washington Mutual transaction, the Firm recorded
adjustments to its provision for credit losses in the aggregate amount of $1.5 billion to conform
the Washington Mutual loan loss reserve methodologies to the appropriate JPMorgan Chase
methodology, based upon the nature and characteristics of the underlying loans. This amount
included an adjustment of $646 million to the wholesale provision for credit losses and an
adjustment of $888 million to the consumer provision for credit losses. The Firm’s methodologies
for determining its allowance for credit losses, which have been applied to the Washington Mutual
loans, are described more fully below.
JPMorgan Chase’s allowance for loan losses covers the wholesale (risk-rated) and consumer (scored)
loan portfolios and represents management’s estimate of probable credit losses inherent in the
Firm’s loan portfolio. Management also computes an allowance for wholesale lending-related
commitments using a methodology similar to that used for the wholesale loans.
The allowance for loan losses includes an asset-specific component and a formula-based component.
The asset-specific component relates to provisions for losses on loans considered impaired and
measured pursuant to SFAS 114. An allowance is established when the discounted cash flows (or
collateral value or observable market price) of the loan is lower than the carrying value of that
loan. To compute the asset-specific component of the allowance, larger impaired loans are evaluated
individually, and smaller impaired loans are evaluated as a pool using historical loss experience
for the respective class of assets. An allowance for loan losses will also be recorded for
purchased credit-impaired loans accounted for in accordance with SOP 03-3 if there are probable
decreases in expected future cash flows other than decreases related to repricing of variable rate
loans. Any required allowance would be measured based on the present value of expected cash flows
discounted at the loan’s (or pool’s) effective interest rate. For additional information on
purchased credit-impaired loans, see Note 14 on pages 165 - 166 of this Annual Report.
The formula-based component covers performing wholesale and consumer loans. For risk-rated loans
(generally loans originated by the wholesale lines of business), it is based on a statistical
calculation, which is adjusted to take into consideration model imprecision, external factors and
current economic events that have occurred but are not yet reflected in the factors used to derive
the statistical calculation. The statistical calculation is the product of probability of default
(“PD”) and loss given default (“LGD”). These factors are differentiated by risk rating and expected
maturity. PD estimates are based on observable external data, primarily credit-rating agency
default statistics. LGD estimates are based on a study of actual credit losses over more than one
credit cycle. For scored loans (generally loans originated by the consumer lines of business), loss
is primarily determined by applying statistical loss factors, including loss frequency and severity
factors, to pools of loans by asset type. In developing loss frequency and severity assumptions,
known and anticipated changes in the economic environment, including changes in housing prices,
unemployment rates and other risk indicators, are considered. Multiple forecasting methods are used
to estimate statistical losses, including credit loss forecasting models and vintage-based loss
forecasting.
Management applies its judgment within specified ranges to adjust the statistical calculation.
Where adjustments are made to the statistical calculation for the risk-rated portfolios, the
determination of the
appropriate point within the range are based upon management’s quantitative and qualitative
assessment of the quality of underwriting standards; relevant internal factors affecting the credit
quality of the current portfolio; and external factors such as current macroeconomic and political
conditions that have occurred but are not yet reflected in the loss factors. Factors related to
concentrated and deteriorating industries are also incorporated into the calculation, where
relevant. Adjustments to the statistical calculation for the scored loan portfolios are
accomplished in part by analyzing the historical loss experience for each major product segment.
The specific ranges and the determination of the appropriate point within the range are based upon
management’s view of uncertainties that relate to current macroeconomic and political conditions,
the quality of underwriting standards, and other relevant internal and external factors affecting
the credit quality of the portfolio.
The allowance for lending-related commitments represents management’s estimate of probable credit
losses inherent in the Firm’s process of extending credit. Management establishes an asset-specific
allowance for lending-related commitments that are considered impaired and computes a formula-based
allowance for performing wholesale lending-related commitments. These are computed using a
methodology similar to that used for the wholesale loan portfolio, modified for expected maturities
and probabilities of drawdown.
Determining the appropriateness of the allowance is complex and requires judgment by management
about the effect of matters that are inherently uncertain. Subsequent evaluations of the loan
portfolio, in light of the factors then prevailing, may result in significant changes in the
allowances for loan losses and lending-related commitments in future periods.
At least quarterly, the allowance for credit losses is reviewed by the Chief Risk Officer, the
Chief Financial Officer and the Controller of the Firm and discussed with the Risk Policy and Audit
Committees of the Board of Directors of the Firm. As of December 31, 2008, JPMorgan Chase deemed
the allowance for credit losses to be appropriate (i.e., sufficient to absorb losses that are
inherent in the portfolio, including those not yet identifiable).
The table below summarizes the changes in the allowance for loan losses.
Year ended December 31, (in millions)
2008
2007
2006
Allowance for loan losses at
January 1
$
9,234
$
7,279
$
7,090
Cumulative effect of change in
accounting principles(a)
—
(56
)
—
Allowance for loan losses at
January 1, adjusted
9,234
7,223
7,090
Gross charge-offs
10,764
5,367
3,884
Gross (recoveries)
(929
)
(829
)
(842
)
Net charge-offs
9,835
4,538
3,042
Provision for loan losses
Provision excluding accounting
conformity
19,660
6,538
3,153
Provision
for loan losses – accounting
conformity(b)
1,577
—
—
Total provision for loan losses
21,237
6,538
3,153
Addition resulting from
Washington Mutual transaction
2,535
—
—
Other(c)
(7
)
11
78
Allowance for loan losses at
December 31
$
23,164
$
9,234
$
7,279
Components:
Asset-specific
$
786
$
188
$
118
Formula-based
22,378
9,046
7,161
Total Allowance for loan losses
$
23,164
$
9,234
$
7,279
(a)
Reflects the effect of the adoption of SFAS 159 at January 1, 2007. For a further
discussion of SFAS 159, see Note 5 on pages 144–146 of this Annual Report.
(b)
Relates to the Washington Mutual transaction in 2008.
(c)
The 2008 amount represents foreign-exchange translation. The 2007 amount
represents assets acquired of $5 million and $5 million of foreign-exchange translation.
The 2006 amount represents the Bank of New York transaction.
The table below summarizes the changes in the allowance for lending-related commitments.
Year ended December 31, (in millions)
2008
2007
2006
Allowance for lending-related
commitments at January 1
$
850
$
524
$
400
Provision for lending-related commitments
Provision excluding accounting
conformity
(215
)
326
117
Provision for lending-related commitments
– accounting
conformity(a)
(43
)
—
—
Total provision for lending-related
commitments
(258
)
326
117
Addition resulting from Washington Mutual
66
—
—
Other(b)
1
—
7
Allowance for lending-related
commitments at December 31
$
659
$
850
$
524
Components:
Asset-specific
$
29
$
28
$
33
Formula-based
630
822
491
Total allowance for lending-
related commitments
$
659
$
850
$
524
(a)
Related to the Washington Mutual transaction.
(b)
The 2006 amount represents the Bank of New York transaction.
Note
16 – Loan securitizations
JPMorgan Chase securitizes and sells a variety of loans, including residential mortgage, credit
card, automobile, student, and commercial loans (primarily related to real estate). JPMorgan
Chase-sponsored securitizations utilize SPEs as part of the securitization process. These SPEs are
structured to meet the definition of a QSPE (as discussed in Note 1 on page 122 of this Annual
Report); accordingly, the assets and liabilities of securitization-related QSPEs are not reflected
on the Firm’s Consolidated Balance Sheets (except for retained interests, as described below). The
primary purpose of these securitization vehicles is to meet investor needs and to generate
liquidity for the Firm through the sale of loans to the QSPEs. These QSPEs are financed through the
issuance of fixed, or floating-rate asset-backed securities.
The Firm records a loan securitization as a sale when the accounting criteria for a sale are met.
Those criteria are: (1) the transferred assets are legally isolated from the Firm’s creditors; (2)
the entity can pledge or exchange the financial assets, or if the entity is a QSPE, its investors
can pledge or exchange their
interests; and (3) the Firm does not maintain effective control to repurchase the transferred
assets before their maturity or have the ability to unilaterally cause the holder to return the
transferred assets.
For loan securitizations that meet the accounting sales criteria, the gains or losses recorded
depend, in part, on the carrying amount of the loans sold except for servicing assets which are
initially recorded at fair value. At the time of sale, any retained servicing asset is initially
recognized at fair value. The remaining carrying amount of the loans sold is allocated between the
loans sold and the other interests retained, based upon their
relative fair values on the date of
sale. Gains on securitizations are reported in noninterest revenue.
When quoted market prices are not available, the Firm estimates the fair
value for these retained interests by calculating the present value of future expected cash flows
using modeling techniques. Such models incorporate management’s best estimates of key variables,
such as expected credit losses, prepayment speeds and the discount rates appropriate for the risks
involved. See Note 4 on page 132 of this Annual Report for further information on the valuation of
retained interests.
The Firm may retain interests in the securitized loans in the form of undivided seller’s interest,
senior or subordinated interest-only strips, debt and equity tranches, escrow accounts and
servicing rights. The classification of retained interests is dependent upon several factors,
including the type of interest, whether or not the retained interest is represented by a security
certificate and when it was retained. Interests retained by IB are classified as trading assets.
See credit card securitizations and mortgage securitizations sections
of the note for further information on the classification of their
related retained
interests. Retained interests classified as AFS that are rated below “AA” by an external rating agency
are subject to the impairment provisions of EITF 99-20, as discussed in Note 12 on page 162 of this
Annual Report.
The following table presents the total unpaid principal amount of assets held in JPMorgan
Chase-sponsored securitization entities, for which sale accounting was achieved and to which the
Firm has continuing involvement, at December 31, 2008 and 2007. Continuing involvement includes
servicing the loans, holding senior or subordinated interests, recourse or guarantee arrangements and derivative transactions. In certain
instances, the Firm’s only continuing involvement is servicing
the loans. Certain of the Firm’s retained interests
(trading assets, AFS securities and other assets) are reflected at their fair value.
Includes co-sponsored commercial securitizations and, therefore, includes
non-JPMorgan Chase originated commercial mortgage loans. Commercial and other consists of securities backed by commercial loans
(predominantly real estate) and non-mortgage related consumer receivables purchased from
third parties. The Firm generally does not retain a residual interest in the Firm’s sponsored
commercial mortgage securitization transactions.
(c)
Includes securitized loans where the Firm owns less than a majority of the
subordinated or residual interests in the securitizations.
(d)
Includes securitization-related QSPEs sponsored by heritage Bear Stearns and
heritage Washington Mutual at December 31, 2008.
(e)
Includes credit card loans, accrued interest and fees, and cash amounts
on deposit.
(f)
Excludes retained servicing (for a discussion of MSRs, see Note 18 on pages
187–188 of this Annual Report).
(g)
Excludes senior and subordinated securities of $974 million at December31, 2008, that the Firm purchased in connection with IB’s
secondary market-making
activities.
(h)
Includes investments acquired in the secondary market, but
predominantly held-for-investment purposes of $1.8 billion as of
December 31, 2008. This is comprised of $1.4 billion of
investments classified as available-for-sale, including
$172 million in credit cards, $693 million of
residential mortgages and $495 million of commercial and other;
and $452 million of investments classified as trading, including
$112 million of credit cards, $303 million of residential
mortgages, and $37 million of commercial and other.
(i)
Excludes interest rate and foreign exchange derivatives that are primarily used to
manage the interest rate and foreign exchange risks of the securitization entities. See
Note 6 and Note 32 on pages 146–147 and 202–205, respectively, of this Annual Report for
further information on derivatives.
(j)
Excludes senior and subordinated securities of
$9.8 billion at December 31, 2007, that were retained at the
time of securitization in connection with IB’s underwriting
activity or that are purchased in connection with IB’s secondary
market-making activities.
Securitization activity by major product type
The following discussion describes the nature of the Firm’s securitization activities by major
product type.
Credit Card Securitizations
The Card Services (“CS”) business securitizes originated and purchased credit card loans. The Firm’s primary
continuing involvement includes servicing the receivables, retaining an undivided seller’s interest
in the receivables, retaining certain senior and subordinated securities and the maintenance of
escrow accounts.
CS maintains servicing responsibilities for all credit card securitizations that it sponsors. As
servicer and transferor, the Firm receives contractual servicing fees based upon the securitized
loan balance plus excess servicing fees, which are recorded in credit card income as discussed in
Note 7 on pages 148–149 of this Annual Report.
The agreements with the credit card securitization trusts require the Firm to maintain a minimum
undivided interest in the trusts (which generally ranges from 4% to
12%). At December 31, 2008 and 2007, the Firm had $33.3 billion
and $18.6 billion, respectively, related to its undivided
interests in the trusts. The Firm maintained an average undivided
interest in principal receivables in the trusts of approximately 22%
and 19% for the years ended December 31, 2008 and 2007,
respectively. These undivided interests in the trusts represent the
Firm’s undivided interests in the receivables transferred to the
trust that have not been securitized; these undivided interests are
not represented by security certificates, are carried at historical
cost, and are classified within loans.
Additionally,
the Firm retained subordinated interest in accrued interest and fees
on the securitized receivables totaling $3.0 billion and
$2.7 billion (net of an allowance for uncollectible amounts) as
of December 31, 2008 and 2007, respectively, which are
classified in other assets.
The Firm retained subordinated securities
in credit card securitization trusts totaling $2.3
billion and $284 million at December 31, 2008 and
2007, respectively, and senior securities totaling
$3.5 billion at December 31, 2008. Of the
securities retained, $5.4 billion and $284 million
were classified as AFS securities at December 31,2008 and 2007, respectively. Securities of $389
million that were acquired in the
Washington Mutual Bank transaction were classified
as trading assets at December 31, 2008.
The senior AFS securities were used by the Firm as
collateral for a secured financing transaction.
The Firm also maintains escrow accounts up to
predetermined limits for some credit card
securitizations to cover deficiencies in cash flows
owed to investors. The amounts available in such
escrow accounts related to credit cards are
recorded in other assets and amounted to $74
million and $97 million as of December31, 2008 and 2007, respectively.
Mortgage Securitizations
The Firm securitizes originated and purchased
residential mortgages and originated commercial
mortgages.
RFS securitizes residential mortgage loans that it
originates and purchases and it typically retains
servicing for all of its originated and purchased
residential mortgage loans. Additionally, RFS may
retain servicing for certain mortgage loans
purchased by IB. As servicer, the Firm receives
servicing fees based upon the securitized loan
balance plus ancillary fees. The Firm also retains
the right to service the residential mortgage loans
it sells to the Government National Mortgage
Association (“GNMA”), Federal National Mortgage Association
(“Fannie Mae”) and Federal Home Loan Mortgage Corporation
(“Freddie Mac”) in
accordance with their servicing guidelines and
standards. For a discussion of MSRs, see Note 18 on
pages 187–188 of this Annual Report. In a limited
number of securitizations, RFS may retain an
interest in addition to servicing rights. The
amount of interest retained related to these
securitizations totaled $939 million and $221
million at December 31, 2008 and 2007,
respectively. These retained interests are
accounted for as trading or AFS securities; the classification
depends on whether the retained interest is represented by a security
certificate, has an embedded derivative, and when it was retained
(i.e., prior to the adoption of SFAS 155).
IB securitizes residential mortgage loans
(including those that it purchased and certain
mortgage loans originated by RFS) and commercial
mortgage loans that it originated. Upon
securitization, IB may engage in underwriting and
trading activities of the securities issued by the
securitization trust. IB may retain unsold senior
and/or subordinated interests (including residual
interests) in both residential and commercial
mortgage securitizations at the time of
securitization. These retained interests are
accounted for at fair value and classified as
trading assets. The amount of residual interests
retained was $155 million and $547 million at
December 31, 2008 and 2007, respectively.
Additionally, IB retained $2.8 billion of senior
and subordinated interests as of December 31, 2008; these
securities were retained at securitization in connection with the
Firm’s underwriting activity.
In addition to the amounts reported in the
securitization activity tables below, the Firm sold
residential mortgage loans totaling $122.0 billion,
$81.8 billion and $53.7 billion during the years
ended December 31, 2008, 2007 and 2006,
respectively. The majority of these loan sales were
for securitization by the GNMA, Fannie Mae and
Freddie Mac. These sales resulted in pretax gains
of $32 million, $47 million and $251 million,
respectively.
The Firm’s mortgage loan sales are primarily
nonrecourse, thereby effectively transferring the
risk of future credit losses to the purchaser of
the loans. However, for a limited number of loan
sales, the Firm is obligated to share up to 100% of
the credit risk associated with the sold loans with
the purchaser. See Note 33 on page 209 of this
Annual Report for additional information on loans
sold with recourse.
Other Securitizations
The Firm also securitizes automobile and student
loans originated by RFS and purchased consumer
loans (including automobile and student loans). The
Firm retains servicing responsibilities for all
originated and certain purchased student and
automobile loans. It may also hold a retained
interest in these securitizations; such residual
interests are classified as other assets. At
December 31, 2008 and 2007, the Firm held $37
million and $85 million, respectively, of retained
interests in securitized automobile loans and $52 million and $55 million,
respectively, of retained interests in securitized
student loans.
The Firm also maintains escrow accounts up to
predetermined limits for some automobile and
student loan securitizations to cover deficiencies
in cash flows owed to investors. These escrow
accounts are classified within other assets and
carried at fair value. The amounts available in
such escrow accounts as of December 31, 2008, were
$3 million for both automobile and student loan
securitizations; as of December 31, 2007, these
amounts were $21 million and $3 million for
automobile and student loan securitizations,
respectively.
Securitization activity
The following tables provide information related to the Firm’s securitization activities for the
years ended December 31, 2008, 2007 and 2006. For the periods presented there were no cash flows
from the Firm to the QSPEs related to recourse or guarantee arrangements.
Proceeds from collections reinvested
in revolving securitizations
151,186
—
—
—
—
—
—
Purchases of previously transferred
financial assets (or the underlying
collateral)(b)
—
31
31
—
—
—
138
Cash flows received on the interests
that continue to be held by the
Firm(d)
76
48
258
—
73
—
96
Key assumptions used to measure retained
interests originated during the year
(rates per annum):
Prepayment
rate(e)
20.0-22.2
%
10.0-41.3
%
36.0-45.0
%
0.0-36.2
%
1.4-1.5
%
PPR
CPR
CPR
CPR
ABS
Weighted-average life (in years)
0.4
1.7-4.0
1.5-2.4
1.5-6.1
1.4-1.9
Expected credit losses
3.3-4.2
%
0.1-3.3
%(j)
1.1-2.1
%
0.0-0.9%
(j)
0.3-0.7
%
Discount rate
12.0
%
8.4-26.2
%
15.1-22.0
%
3.8-14.0
%
7.6-7.8
%
(a)
Other cash flows received include excess servicing fees and other ancillary fees
received.
(b)
Includes cash paid by the Firm to reacquire assets from the QSPEs, for example,
servicer clean-up calls.
(c)
Excludes a random removal of $6.2 billion of credit card
loans from a securitization trust previously established by
Washington Mutual and an account addition of $5.8 billion of
higher quality credit card loans from the legacy Chase portfolio to
the legacy Washington Mutual trust in
November 2008. These are
noncash transactions that are permitted by the trust documents in
order to maintain the appropriate level of undivided seller’s
interest.
(d)
Includes cash flows received on retained interests including, for example,
principal repayments, and interest payments.
Includes $5.5 billion of securities retained by the Firm.
(g)
Includes securitizations sponsored by Bear Stearns and Washington Mutual as of
their respective acquisition dates.
(h)
Includes Alt-A loans.
(i)
As of January 1, 2007, the Firm adopted the fair value election for IB warehouse
and the RFS prime mortgage warehouse. The carrying value of these loans accounted for at
fair value approximates the proceeds received from securitization.
(j)
Expected credit losses for consumer prime residential mortgage, and student and
certain other securitizations are minimal and are incorporated into other assumptions.
The following table summarizes the Firm’s retained securitization interests, which are carried at
fair value on the Firm’s Consolidated Balance Sheets at
December 31, 2008. As of December 31, 2008, 55% of
the Firm’s retained securitization interests, which are carried at fair value, were risk rated “A”
or better.
Ratings
profile of retained interests(c)(d)
2008
Investment
Noninvestment
Retained
December 31, (in billions)
Grade
grade
interest
Asset types:
Credit card(a)
$
5.5
$
3.8
$
9.3
Residential mortgage:
Prime(b)
1.1
0.3
1.4
Subprime
—
0.1
0.1
Option ARMs
0.4
—
0.4
Commercial and other
1.7
0.3
2.0
Student loans
—
0.1
0.1
Auto
—
—
—
Total
$
8.7
$
4.6
$
13.3
(a)
Includes retained subordinated interests carried at fair value, including CS’
accrued interests and fees, escrow accounts, and other residual interests. Excludes
undivided seller interest in the trusts of $33.3 billion at December 31,2008, which is carried at historical cost, and unencumbered cash
amounts on deposit of $2.1 billion at December 31, 2008.
(b)
Includes Alt-A loans.
(c)
The ratings scale is presented on an S&P-equivalent basis.
(d)
Excludes $1.8 billion of investments acquired in the
secondary market, but predominantly held for investment purposes. Of
this amount $1.7 billion is classified as investment grade.
The table below outlines the key economic assumptions used at December 31, 2008 and 2007, to
determine the fair value as of December 31, 2008 and 2007, respectively, of the Firm’s retained
interests, other than MSRs, that are valued using modeling
techniques; it excludes securities that are valued using quoted
market prices. The table below also
outlines the sensitivities of those fair values to immediate 10% and 20% adverse changes in
assumptions used to determine fair value. For a discussion of residential MSRs, see Note 18 on
pages 187–188 of this Annual Report.
Excludes certain interests that are not valued using modeling
techniques.
(c)
Includes Alt-A loans.
(d)
Including the valuation assumptions used to determine the fair value
for a limited amount of retained interests resulted in a wider range
than those used for the
majority of the portfolio. Excluding these retained interests, the
range of assumptions used to value the prime/Alt A mortgage
retained interests would have been 0.0-29.4% for prepayment rates;
0.0-25.0% for loss assumptions; and 9.9%-21.4% for the discount rates.
(e)
Expected losses for prime residential mortgage, student loans and certain wholesale securitizations are minimal and are incorporated into other assumptions.
(f)
Including the loss assumptions used to determine the fair value for a
limited amount of retained interests resulted in a wider range than those used for the
majority of the portfolio. Excluding these retained interests, the range of loss assumption
used to value the subprime mortgage retained interests would have
been 0.2-43.5%.
(g)
The valuation assumptions used to determine the fair value
for a limited amount of retained interests were higher than the
majority of the portfolio. Excluding these retained interests, the
range of assumptions used to value the commercial and other retained
interests would have been 0.0% to 22.0% for prepayment rates and
3.3%-30.4% for the discount rates.
The sensitivity analysis in the preceding table
is hypothetical. Changes in fair value based upon a
10% or 20% variation in assumptions generally
cannot be extrapolated easily because the
relationship of the change in the assumptions to
the change in fair value may not be linear. Also,
in the table, the effect that a change in a
particular assumption may have on the fair value is
calculated without changing any other assumption.
In reality, changes in one factor may result in
changes in another, which might counteract or
magnify the sensitivities. The above sensitivities
also do not reflect the Firm’s risk management
practices that may be undertaken to mitigate such
risks.
The table below includes information about delinquencies, net charge-offs and
components of reported and securitized financial assets at December 31, 2008 and 2007.
90 days past due
Nonaccrual
Net loan charge-offs
Total Loans
and still accruing
assets(g)(h)
Year ended
December 31, (in millions)
2008
2007
2008
2007
2008
2007
2008
2007
Home Equity
$
114,335
$
94,832
$
—
$
—
$
1,394
$
786
$
2,391
$
564
Prime mortgage(a)
72,266
39,988
—
—
1,895
501
526
33
Subprime mortgage
15,330
15,473
—
—
2,690
1,017
933
157
Option ARMs
9,018
—
—
—
10
—
—
—
Auto loans
42,603
42,350
—
—
148
116
568
354
Credit card
104,746
84,352
2,649
1,547
4
7
4,556
3,116
All other loans
33,715
25,314
463
421
430
341
459
242
Loans held-for-sale(b)
2,028
3,989
—
—
—
—
NA
NA
Total
consumer loans –
excluding purchased
credit-impaired
394,041
306,298
3,112
1,968
6,571
2,768
9,433
4,466
Consumer
loans – purchased credit-impaired(c)
88,813
—
—
—
—
—
—
—
Total consumer loans
482,854
306,298
3,112
1,968
6,571
2,768
9,433
4,466
Total wholesale loans
262,044
213,076
163
75
2,382
(i)
514
(i)
402
72
Total loans reported
744,898
519,374
3,275
2,043
8,953
3,282
9,835
4,538
Securitized loans:
Residential mortgage:
Prime
mortgages(a)
212,274
77,582
—
—
21,130
1,215
5,645
7
Subprime mortgage
58,607
22,692
—
—
13,301
3,238
4,797
413
Option ARMs
48,328
—
—
—
6,440
—
270
—
Automobile
791
2,276
—
—
2
6
15
13
Credit card
85,571
72,701
1,802
1,050
—
—
3,612
2,380
Student
1,074
1,141
66
—
—
—
1
—
Commercial and other
45,677
3,419
28
—
166
—
8
11
Total loans securitized(d)
$
452,322
$
179,811
$
1,896
$
1,050
$
41,039
$
4,459
$
14,348
$
2,824
Total loans
reported and
securitized(e)
$
1,197,220
(f)
$
699,185
(f)
$
5,171
$
3,093
$
49,992
$
7,741
$
24,183
$
7,362
(a)
Includes Alt-A loans.
(b)
Includes loans for prime mortgage and other (largely student loans) of $206
million and $1.8 billion at December 31, 2008, respectively, and $570 million and $3.4
billion at December 31, 2007, respectively.
(c)
Purchased credit-impaired loans represent loans acquired in the Washington Mutual
acquisition that were considered credit-impaired under SOP 03-3, and include $6.4 billion
of loans that were nonperforming immediately prior to the acquisition. Under SOP 03-3,
these loans are considered to be performing loans as of the acquisition date; they accrete
interest income over the estimated life of the loan when cash flows are reasonably
estimable, even if the underlying loans are contractually past due. For additional
information, see Note 14 on pages 163–166 of this Annual Report.
(d)
Total assets held in securitization-related SPEs were
$640.8 billion and $307.7 billion at December 31, 2008
and 2007, respectively. The $452.3 billion and
$179.8 billion of loans securitized at December 31, 2008
and 2007, respectively, excludes $152.4 billion and
$107.8 billion of securitized loans, respectively, in which the
Firm has no continuing involvement; $33.3 billion and
$18.6 billion of seller’s interests in credit card master
trusts, respectively; and $2.8 billion and $1.5 billion of
cash amounts on deposit and escrow accounts.
(e)
Represents both loans on the Consolidated Balance Sheets and loans that have been
securitized.
(f)
Includes securitized loans that were previously recorded at fair value and
classified as trading assets.
(g)
During the second quarter of 2008, the policy for classifying subprime mortgage and home equity loans as
nonperforming was changed to conform to all other home lending
products. Amounts for 2007 have been revised to reflect this change.
(h)
Excludes nonperforming assets related to (i) loans eligible for repurchase, as
well as loans repurchased from GNMA pools that are insured by U.S. government agencies, of
$3.3 billion and $1.5 billion at December 31, 2008 and 2007, respectively, and (ii)
student loans that are 90 days past due and still accruing, which are insured by U.S.
government agencies under the Federal Family Education Loan Program, of $437 million and
$417 million at December 31, 2008 and 2007, respectively. These amounts for GNMA and
student loans are excluded, as reimbursement is proceeding normally.
(i)
Includes nonperforming loans held-for-sale and loans at fair value of $32 million
and $50 million at December 31, 2008 and 2007, respectively.
Subprime adjustable-rate mortgage loan modifications
See the Glossary of Terms on page 220 of this
Annual Report for the Firm’s definition of subprime
loans. Within the confines of the limited
decision-making abilities of a QSPE under SFAS 140,
the operating documents that govern existing
subprime securitizations generally authorize the
servicer to modify loans for which default is
reasonably foreseeable, provided that the
modification is in the best interests of the QSPE’s
beneficial interest holders and would not result in
a REMIC violation.
In December 2007, the American Securitization Forum
(“ASF”) issued the “Streamlined Foreclosure and
Loss Avoidance Framework for Securitized Subprime
Adjustable Rate Mortgage Loans” (the “Framework”).
The Framework provides guidance for servicers to
streamline evaluation procedures for borrowers with
certain subprime adjustable rate mortgage (“ARM”)
loans to more efficiently provide modifications of
such loans with terms that are more appropriate for
the individual needs of such borrowers. The
Framework applies to all first-lien subprime ARM
loans that have a fixed rate of interest for an
initial period of 36 months or less, are included
in securitized pools, were originated between
January 1, 2005, and July 31, 2007, and have an
initial interest rate reset date between January 1,2008, and July 31, 2010 (“ASF Framework Loans”).
The Framework categorizes the population of ASF
Framework Loans into three segments: Segment 1
includes loans where the borrower is current and is
likely
to be able to refinance into any readily available
mortgage product; Segment 2 includes loans where
the borrower is current, is unlikely to be able to
refinance into any readily available mortgage
industry product and meets certain defined
criteria; and Segment 3 includes loans where the
borrower is not current, as defined, and does not
meet the criteria for Segments 1 or 2.
ASF Framework Loans in Segment 2 of the Framework
are eligible for fast-track modification under
which the interest rate will be kept at the
existing initial rate, generally for five years
following the interest rate reset date. The
Framework indicates that for Segment 2 loans,
JPMorgan Chase, as servicer, may presume that the
borrower will be unable to make payments pursuant
to the original terms of the borrower’s loan after
the initial interest rate reset date. Thus, the
Firm may presume that a default on that loan by the
borrower is reasonably foreseeable unless the terms
of the loan are modified. JPMorgan Chase has
adopted the loss mitigation approaches under the
Framework for securitized subprime ARM loans that
meet the specific Segment 2 criteria and began
modifying Segment 2 loans during the first quarter
of 2008. The adoption of the Framework did not
affect the off-balance sheet accounting treatment
of JPMorgan Chase-sponsored QSPEs that hold Segment
2 subprime loans.
The total dollar amount of assets owned by
Firm-sponsored QSPEs that hold subprime adjustable
rate mortgage loans as of December 31, 2008 and
2007, was $30.8 billion and $20.0 billion,
respectively. Of these amounts, $12.7 billion and
$9.7 billion, respectively, are related to ASF
Framework Loans serviced by the Firm. Included
within the assets owned by Firm-sponsored QSPEs was
foreclosure-related real estate owned, for which
JPMorgan Chase is the servicer, in
the amount of $3.5 billion and $637 million at
December 31, 2008 and 2007, respectively. The
growth in real estate owned in 2008 is
attributable to the Washington Mutual transaction
and increased foreclosures resulting from current
housing market conditions. The following table
presents the principal amounts of ASF Framework
Loans, serviced by the Firm, that are owned by
Firm-sponsored QSPEs that fell within Segments 1,
2 and 3 as of December 31, 2008 and 2007,
respectively.
The estimates of segment classification could
change substantially in the future as a result of
future changes in housing values, economic
conditions, borrower/investor behavior and other
factors.
The total principal amount of beneficial
interests issued by the Firm-sponsored
securitizations that hold ASF Framework Loans as
of December 31, 2008 and 2007, was as follows.
December 31, (in millions)
2008
2007
Third-party
$
44,401
$
19,636
Retained interest
99
412
Total
$
44,500
$
20,048
For those ASF Framework Loans serviced by the Firm
and owned by Firm-sponsored QSPEs, the Firm
modified principal amounts of $1.7 billion of
Segment 2 subprime mortgages during the year ended
December 31, 2008. There were no Segment 2 subprime
mortgages modified during the year ended December31, 2007. For Segment 3 loans, the Firm has adopted
a loss mitigation approach, without employing the
fast-track modifications prescribed for Segment 2
subprime mortgages, that is intended to maximize
the recoveries of the securitization trust. The
loss mitigation approach chosen by JPMorgan Chase
is consistent with the applicable servicing
agreements and could include rate reductions,
principal forgiveness, forbearance and other
actions intended to minimize economic loss and
avoid foreclosure. The table below presents
selected information relating to the principal
amount of Segment 3 loans for the year ended
December 31, 2008, including those that have been modified,
subjected to other loss mitigation activities or have been prepaid by
the borrower.
For the year ended
December 31, (in millions)
2008
Loan modifications
$
2,384
Other loss mitigation activities
865
Prepayments
219
The impact of loss mitigation efforts on the
fair value of the Firm’s retained interests in ASF
Framework loans was not material at December 31,2008.
Refer to Note 1 on page 122 of this Annual
Report for a further description of JPMorgan
Chase’s policies regarding consolidation of
variable interest entities.
JPMorgan Chase’s principal involvement with VIEs
occurs in the following business segments:
•
Investment Bank: Utilizes VIEs to assist clients in accessing the financial markets
in a cost-efficient manner. IB is involved with VIEs through multi-seller conduits and for
investor intermediation purposes, as discussed below. IB also securitizes loans through
QSPEs, to create asset-backed securities, as further discussed in Note 16 on pages
168–176 of this Annual Report.
•
Asset Management (“AM”): Provides investment management services to a limited number
of the Firm’s funds deemed VIEs. AM earns a fixed fee based upon assets managed; the fee varies with each fund’s investment
objective and is competitively priced. For the limited number of funds that qualify as
VIEs, AM’s relationships with such funds are not considered significant variable interests
under FIN 46(R).
•
Treasury & Securities Services: Provides services to a number of VIEs that are
similar to those provided to non-VIEs. TSS earns market-based fees for the services it
provides. The relationships resulting from TSS’ services are not considered to be
significant variable interests under FIN 46(R).
•
Commercial Banking (“CB”): Utilizes VIEs to assist clients in accessing the
financial markets in a cost-efficient manner. This is often accomplished through the use
of products similar to those offered in IB. CB may assist in the structuring and/or
ongoing administration of these VIEs and may provide liquidity, letters of credit and/or
derivative instruments in support of the VIE. The relationships resulting from CB’s
services are not considered to be significant variable interests under FIN 46(R).
•
Corporate/Private Equity: Corporate utilizes VIEs to issue guaranteed capital debt
securities. See Note 23 on page 191 for further information. The Private Equity business,
also included in Corporate, may be involved with entities that could be deemed VIEs.
Private equity activities are accounted for in accordance with the AICPA Audit and
Accounting Guide Investment Companies (the “Guide”). In June 2007, the AICPA issued SOP
07-1, which provides guidance for determining whether an entity is within the scope of
the Guide, and therefore qualifies to use the Guide’s specialized accounting principles
(referred to as “investment company accounting”). In May 2007, the FASB issued FSP FIN
46(R)-7, which amends FIN 46(R) to permanently exempt entities within the scope of the
Guide from applying the provisions of FIN 46(R) to their investments. In February 2008,
the FASB agreed to an indefinite delay of the effective date of SOP 07-1 in order to
address implementation issues, which effectively delays FSP FIN 46(R)-7 as well for those
companies, such as the Firm, that have not adopted SOP 07-1. Had FIN 46(R) been applied to
VIEs subject to this deferral, the impact would have been immaterial to the Firm’s
consolidated financial statements as of December 31, 2008.
As noted above, IB is predominantly involved with
multi-seller conduits and VIEs associated with
investor intermediation activities. These
nonconsolidated VIEs that are sponsored by JPMorgan
Chase are discussed below. The Firm considers a
“sponsored” VIE to include any entity where: (1)
JPMorgan Chase is the principal beneficiary of the
structure; (2) the VIE is used by JPMorgan Chase to
securitize Firm assets; (3) the VIE issues
financial instruments associated with the JPMorgan
Chase brand name; or (4) the entity is a JPMorgan
Chase administered asset-backed commercial paper
(“ABCP”) conduit.
Multi-seller conduits Funding and liquidity
The Firm is an active participant in the
asset-backed securities business, and it helps
customers meet their
financing needs by providing access to the
commercial paper markets through VIEs known as
multi-seller conduits. Multi-seller conduit
entities are separate bankruptcy-remote entities
that purchase interests in, and make loans secured
by, pools of receivables and other financial assets
pursuant to agreements with customers of the Firm.
The conduits fund their purchases and loans through
the issuance of highly rated commercial paper to
third-party investors. The primary source of
repayment of the commercial paper is the cash flow
from the pools of assets. In most instances, the
assets are structured with deal-specific credit
enhancements provided by the customers (i.e.,
sellers) to the conduits or other third parties.
Deal-specific credit enhancements are generally
structured to cover a multiple of historical losses
expected on the pool of assets, and are typically
in the form of overcollateralization provided by
the seller, but also may include any combination of
the following: recourse to the seller or
originator, cash collateral accounts, letters of
credit, excess spread, retention of subordinated
interests or third-party guarantees. The
deal-specific credit enhancements mitigate the
Firm’s potential losses on its agreements with the
conduits.
JPMorgan Chase receives fees related to the
structuring of multi-seller conduit transactions
and compensation from the multi-seller conduits
for its role as administrative agent, liquidity
provider, and provider of program-wide credit
enhancement.
As a means of ensuring timely repayment of the
commercial paper, each asset pool financed by the
conduits has a minimum 100% deal-specific liquidity
facility associated with it. Deal-specific
liquidity facilities are the primary source of
liquidity support for the conduits. The
deal-specific liquidity facilities are typically in
the form of asset purchase agreements and generally
structured so the liquidity that will be provided
by the Firm as liquidity provider will be effected
by the Firm purchasing, or lending against, a pool
of nondefaulted, performing assets.
The conduit’s administrative agent can require the
liquidity provider to perform under its asset
purchase agreement with the conduit at any time.
These agreements may cause the liquidity provider,
including the Firm, to purchase an asset from the
conduit at an amount above the asset’s then current
fair value – in effect providing a guarantee of
the initial value of the reference asset as of the
date of the agreement. In limited circumstances,
the Firm may provide unconditional liquidity.
The Firm also provides the multi-seller conduit
vehicles with program-wide liquidity facilities in
the form of uncommitted short-term revolving
facilities that can be accessed by the conduits to
handle funding increments
too small to be funded by commercial paper and in
the form of uncommitted liquidity facilities that
can be accessed by the conduits only in the event
of short-term disruptions in the commercial paper
market.
Because the majority of the deal-specific liquidity
facilities will only fund nondefaulted assets,
program-wide credit enhancement is required to
absorb losses on defaulted receivables in excess of
losses absorbed by any deal-specific credit
enhancement. Program-wide credit enhancement may be
provided by JPMorgan Chase in the form of standby
letters of credit or by third-party surety bond
providers. The amount of program-wide credit
enhancement required varies by conduit and ranges
between 5% and 10% of applicable commercial paper
outstanding.
The following table summarizes the Firm’s
involvement with non-consolidated Firm-administered
multi-seller conduits. There were no consolidated
Firm-administered multi-seller conduits as of
December 31, 2008 or 2007.
December 31, (in billions)
2008
2007
Total assets held by conduits
$
42.9
$
61.2
Total
commercial paper issuedby conduits
43.1
62.6
Liquidity and credit enhancements(a)
Deal-specific liquidity facilities
(primary asset purchase agreements)
55.4
87.3
Program-wide liquidity facilities
17.0
13.2
Program-wide credit enhancements
3.0
2.5
Maximum exposure to loss(b)
56.9
88.9
(a)
The accounting for these agreements is further discussed in Note 33 on pages
206–210. The carrying value related to asset purchase agreements was $147 million at
December 31, 2008, of which $138 million represented the
remaining fair value of the guarantee under FIN 45. The Firm has
recognized this guarantee in other liabilities with an offsetting
entry recognized in other assets for the net present value of the
future premium receivable under the contracts.
(b)
The Firm’s maximum exposure to loss is limited to the amount of drawn commitments
(i.e., sellers’ assets held by the multi-seller conduits for which the Firm provides
liquidity support) of $42.9 billion and $61.2 billion at December 31, 2008 and 2007,
respectively, plus contractual but undrawn commitments of $14.0 billion and $27.7 billion
at December 31, 2008 and 2007, respectively. Since the Firm provides credit enhancement
and liquidity to Firm-administered, multi-seller conduits, the
maximum exposure is not
adjusted to exclude exposure that would be absorbed by third- party liquidity providers.
Assets funded by the multi-seller conduits
JPMorgan Chase’s administered multi-seller
conduits fund a variety of asset types for the
Firm’s clients. Asset types primarily include
credit card receivables, auto loans, trade
receivables, student loans, commercial loans,
residential mortgages, capital commitments (e.g.,
loans to private equity, mezzanine and real estate
opportunity funds secured by capital commitments
of highly rated institutional investors), and
various other asset types. It is the Firm’s
intention that the assets funded by its
administered multi-seller conduits be sourced only
from the Firm’s clients and not originated by, or
transferred from, JPMorgan Chase.
The following table presents information on the commitments and assets held by JPMorgan Chase’s
administered multi-seller conduits as of December 31, 2008 and 2007.
Summary of exposure to Firm-administered nonconsolidated multi-seller conduits
The ratings scale is presented on an S&P equivalent basis.
(b)
Weighted average expected life for each asset type is based upon the remaining
term of each conduit transaction’s committed liquidity plus either the expected weighted
average life of the assets should the committed liquidity expire without renewal or the
expected time to sell the underlying assets in the securitization market.
The assets held by the multi-seller conduits
are structured so that if they were rated, the Firm
believes the majority of them would receive an “A”
rating or better by external rating agencies.
However, it is unusual for the assets held by the
conduits to be explicitly rated by an external
rating agency. Instead, the Firm’s Credit Risk
group assigns each asset purchase liquidity
facility an internal risk-rating based upon its
assessment of the probability of default for the
transaction. The ratings provided in the above
table reflect the S&P-equivalent ratings of the
internal rating grades assigned by the Firm.
The risk ratings are periodically reassessed as
information becomes available. As of December 31,2008 and 2007, 90% and 93%, respectively, of the
assets in the conduits were risk-rated “A” or
better.
Commercial paper issued by the multi-seller conduits
The weighted average life of commercial paper
issued by the multi-seller conduits at December 31,2008 and 2007, was 27 days and 26 days,
respectively, and the average yield on the
commercial paper at December 31, 2008 and 2007, was
0.6% and 5.7%, respectively.
In the normal course of business, JPMorgan Chase
trades and invests in commercial paper, including
paper issued by the Firm-administered conduits. The
percentage of commercial paper purchased by the
Firm across all Firm-administered conduits during
the year ended December 31, 2008, ranged from less
than 1% to approximately 20% on any given day. The
largest daily amount of commercial paper
outstanding held by the Firm in any one
multi-seller conduit during the years ended
December 31, 2008 and 2007, was approximately $2.7
billion, or 23%, for 2008, and $2.7 billion, or
16%, for 2007, of the conduit’s commercial
paper outstanding. On average, the Firm held
approximately 3% of daily multi-seller conduit
issued commercial paper outstanding during 2008.
Total multi-seller conduit issued commercial paper
held by the Firm at December 31, 2008 and 2007, was
$360 million and $131 million, respectively.
The Firm is not obligated under any agreement
(contractual or non-contractual) to purchase the
commercial paper issued by JPMorgan
Chase-administered conduits.
Consolidation analysis
The multi-seller conduits administered by the Firm
were not consolidated at December 31, 2008 and
2007, because each conduit had issued expected loss
notes (“ELNs”), the holders of which are committed
to absorbing the majority of the expected loss of
each respective conduit.
Implied support
The Firm did not have and continues not to have
any intent to protect any ELN holders from
potential losses on any of the conduits’ holdings
and has no plans to remove any assets from any
conduit unless required to do so in its role as
administrator. Should such a transfer occur, the
Firm would allocate losses on such assets between
itself and the ELN holders in accordance with the
terms of the applicable ELN.
Expected loss modeling
In determining the primary beneficiary of the
conduits the Firm uses a Monte Carlo–based model
to estimate the expected losses of each of the
conduits and considers the relative rights and
obligations of each of the variable interest
holders. The Firm’s expected loss modeling treats
all variable interests, other than the ELNs, as its
own to determine consolidation. The variability to
be considered in the modeling of expected losses is
based on the design of the entity. The Firm’s
traditional multi-seller conduits are designed to
pass credit risk, not liquidity risk, to its
variable interest holders, as the assets are
intended to be held in the conduit for the longer
term.
Under FIN 46(R), the Firm is required to run the
Monte Carlo-based expected loss model each time a
reconsideration event occurs. In applying this
guidance to the conduits, the following events, are
considered to be reconsideration events, as they
could affect the determination of the primary
beneficiary of the conduits:
•
New deals, including the issuance of new or additional variable interests (credit
support, liquidity facilities, etc);
•
Changes in usage, including the change in the level of outstanding variable
interests (credit support, liquidity facilities, etc);
•
Modifications of asset purchase agreements; and
•
Sales of interests held by the primary beneficiary.
From an operational perspective, the Firm does not
run its Monte Carlo-based expected loss model every
time there is a reconsideration event due to the
frequency of their occurrence. Instead, the Firm
runs its expected loss model each quarter and
includes a growth assumption for each conduit to
ensure that a sufficient amount of ELNs exists for
each conduit at any point during the quarter.
As part of its normal quarterly modeling, the Firm
updates, when applicable, the inputs and
assumptions used in the expected loss model.
Specifically, risk ratings and loss given default
assumptions are continually updated. The total
amount of expected loss notes outstanding at
December 31, 2008 and 2007, were $136 million and
$130 million, respectively. Management has
concluded that the model assumptions used were
reflective of market participants’ assumptions and
appropriately considered the probability of changes
to risk ratings and loss given defaults.
Qualitative considerations
The multi-seller conduits are primarily designed to
provide an efficient means for clients to access
the commercial paper market. The Firm believes the
conduits effectively disperse risk among all
parties and that the preponderance of the economic
risk in the Firm’s multi-seller conduits is not
held by JPMorgan Chase.
Consolidated sensitivity analysis on capital
The table below shows the impact on the Firm’s
reported assets, liabilities, Tier 1 capital ratio
and Tier 1 leverage ratio if the Firm were required
to consolidate all of the multi-seller conduits
that it administers at their current carrying
value.
The table shows the impact of consolidating the assets and liabilities of the
multi-seller conduits at their current carrying value; as such, there would be no income
statement or capital impact at the date of consolidation. If the Firm were required to
consolidate the assets and liabilities of the conduits at fair value, the Tier 1 capital
ratio would be approximately 10.8%. The fair value of the assets is primarily based upon pricing for
comparable transactions. The fair value of these assets could change significantly because
the pricing of conduit transactions is renegotiated with the client, generally, on an
annual basis and due to changes in current market conditions.
(b)
Consolidation is assumed to occur on the first day of the quarter, at the
quarter-end levels, in order to provide a meaningful adjustment to average assets in the
denominator of the leverage ratio.
The Firm could fund purchases of assets
from VIEs should it become necessary.
2007 activity
In July 2007, a reverse repurchase agreement
collateralized by prime residential mortgages held
by a Firm-administered multi-seller conduit was put
to JPMorgan Chase under its deal-specific liquidity
facility. The asset was transferred to and recorded
by JPMorgan Chase at its par value based on the
fair value of the collateral that supported the
reverse repurchase agreement. During the fourth
quarter of 2007, additional information regarding
the value of the collateral, including performance
statistics, resulted in the determination by the
Firm that the fair value of the collateral was
impaired. Impairment losses were allocated to the
ELN holder (the party that absorbs the majority of
the expected loss from the conduit) in accordance
with the contractual provisions of the ELN note.
On October 29, 2007, certain structured CDO assets
originated in the second quarter of 2007 and backed
by subprime mortgages were transferred to the Firm
from two Firm-administered multi-seller conduits.
It became clear in October that commercial paper
investors and rating agencies were becoming
increasingly concerned about CDO assets backed by
subprime mortgage exposures. Because of these
concerns, and to ensure the continuing viability of
the two conduits as financing vehicles for clients
and as investment alternatives for commercial paper
investors, the Firm, in its role as administrator,
transferred the CDO assets out of the multi-seller
conduits. The structured CDO assets were
transferred to the Firm at
their par value of $1.4 billion. As of
December 31, 2008 and 2007, the CDO assets were
valued on the Consolidated Balance Sheets at $5
million and $291 million, respectively.
There were no other structured CDO assets backed
by subprime mortgages remaining in JPMorgan
Chase-administered multi-seller conduits as of
December 31, 2008 and 2007.
The Firm does not consider the October 2007
transfer of the structured CDO assets from the
multi-seller conduits to JPMorgan Chase to be an
indicator of JPMorgan Chase’s intent to provide
implicit support to the ELN holders. This transfer
was a one-time, isolated event, limited to a
specific type of asset that is not typically funded
in the Firm’s administered multi-seller conduits.
In addition, the Firm has no plans to permit
multi-seller conduits to purchase such assets in
the future.
Investor intermediation
As a financial intermediary, the Firm creates
certain types of VIEs and also structures
transactions, typically derivative structures, with
these VIEs to meet investor needs. The Firm may
also provide liquidity and other support. The risks
inherent in the derivative instruments or liquidity
commitments are managed similarly to other credit,
market or liquidity risks to which the Firm is
exposed. The principal types of VIEs for which the
Firm is engaged in these structuring activities are
municipal bond vehicles, credit-linked note
vehicles, asset swap
vehicles and collateralized debt obligation
vehicles.
Municipal bond vehicles
The Firm has created a series of secondary market
trusts that provide short-term investors with
qualifying tax-exempt investments, and that allow
investors in tax-exempt securities to finance their
investments at short-term tax-exempt rates. In a
typical transaction, the vehicle purchases
fixed-rate longer-term highly rated municipal bonds
and funds the purchase by issuing two types of
securities: (1) putable floating-rate certificates
and (2) inverse floating-rate residual interests
(“residual interests”). The maturity of each of the
putable floating-rate certificates and the residual
interests is equal to the life of the vehicle,
while the maturity of the underlying municipal
bonds is longer. Holders of the putable
floating-rate certificates may “put,” or tender,
the certificates if the remarketing agent cannot
successfully remarket the floating-rate
certificates to another investor. A liquidity
facility conditionally obligates the liquidity
provider to fund the purchase of the tendered
floating-rate certificates. Upon termination of the
vehicle, if the proceeds from the sale of the
underlying municipal bonds are not sufficient to
repay the liquidity facility, the liquidity
provider has recourse either to excess
collateralization in the vehicle or the residual
interest holders for reimbursement.
The third-party holders of the residual interests
in these vehicles could experience losses if the
face amount of the putable floating-rate
certificates exceeds the market value of the
municipal bonds upon termination of the vehicle.
Certain vehicles require a smaller initial
investment by the residual interest holders and
thus do not result in excess collateralization. For
these vehicles there exists a reimbursement
obligation which requires the residual interest
holders to post, during the life of the vehicle,
additional collateral to the vehicle on a daily
basis as the market value of the municipal bonds
declines.
JPMorgan Chase often serves as the sole liquidity
provider and remarketing agent of the putable
floating-rate certificates. As the liquidity
provider, the Firm has an obligation to fund the
purchase of the putable floating-rate certificates;
this obligation is triggered by the failure to
remarket the putable floating-rate certificates.
The liquidity provider’s obligation to perform is
conditional and is limited by certain termination
events, which include bankruptcy or failure to pay
by the municipal bond issuer or credit enhancement
provider, and the immediate downgrade of the
municipal bond to below investment grade. A
downgrade of the JPMorgan Chase Bank, N.A.’s
short-term rating does not affect the Firm’s
obligation under the liquidity facility. However,
in the event of a downgrade in the Firm’s credit
ratings, holders of the putable floating-rate
instruments supported by those liquidity facility
commitments might choose to sell their instruments,
which could increase the likelihood that the
liquidity commitments could be drawn. In vehicles
in which third-party investors own the residual
interests, in addition to the termination events,
the Firm’s exposure as liquidity provider is
further limited by the high credit
quality of the underlying municipal bonds, and the
excess collateralization in the vehicle or the
reimbursement agreements with the residual interest
holders. In the fourth quarter of 2008, a drawdown
occurred on one liquidity facility as a result of a
failure to remarket putable floating-rate
certificates. The Firm was required to purchase $19 million of putable floating-rate
certificates. Subsequently, the municipal bond
vehicle was terminated and the proceeds from the
sales of the municipal bonds, together with the
collateral posted by the residual interest holder,
were sufficient to repay the putable floating-rate
certificates. In 2007, the Firm did not experience
a drawdown on the liquidity facilities.
As remarketing agent, the Firm may hold the putable
floating-rate certificates. At December 31, 2008
and 2007, respectively, the Firm held $293 million
and $617 million of these certificates on its
Consolidated Balance Sheets. The largest amount
held by the Firm at any time during 2008 and 2007
was $2.2 billion and $1.0 billion, respectively, or
11% and 5%, respectively, of the municipal bond
vehicles’ outstanding putable floating-rate
certificates. The Firm did not have and continues
not to have any intent to protect any residual
interest holder from potential losses on any of the
municipal bond holdings.
The long-term credit ratings of the putable
floating-rate certificates are directly related to
the credit ratings of the underlying municipal
bonds, and to the credit rating of any insurer of
the underlying municipal bond. A downgrade of a
bond insurer would result in a downgrade of the
insured municipal bonds, which would affect the
rating of the putable floating-rate certificates.
This could cause demand for these certificates by
investors to decline or disappear, as putable
floating-rate certificate holders typically require
an “AA-” bond rating. At December 31, 2008 and
2007, 97% and 99%, respectively, of the municipal
bonds held by vehicles to which the Firm served as
liquidity provider were rated “AA-” or better,
based upon either the rating of the underlying
municipal bond itself, or the rating including any
credit enhancement. At December 31, 2008 and 2007,
$2.6 billion and $12.0 billion, respectively, of
the bonds were
insured by monoline bond insurers. In
addition, the municipal bond vehicles did not
experience any bankruptcy or downgrade
termination events during 2008 and 2007.
The Firm sometimes invests in the residual
interests of municipal bond vehicles. For VIEs in
which the Firm owns the residual interests, the
Firm consolidates the VIEs.
The likelihood that the Firm would have to
consolidate VIEs where the Firm does not own the
residual interests and that are currently
off-balance sheet is remote.
Exposure to nonconsolidated municipal bond VIEs at December 31, 2008 and 2007, including the
ratings profile of the VIEs’ assets, were as follows.
2008
2007
Fair value of
Fair value of
December 31,
assets held
Liquidity
Excess/
Maximum
assets held
Liquidity
Excess/
Maximum
(in billions)
by VIEs
facilities(d)
(deficit)(e)
exposure
by VIEs
facilities(d)
(deficit)(e)
exposure
Nonconsolidated
Municipal bond
vehicles(a)(b)(c)
$
10.0
$
6.9
$
3.1
$
6.9
$
19.2
$
18.1
$
1.1
$
18.1
Fair value
Wt. avg.
Ratings profile of VIE assets(f)
of assets
expected
December 31,
Investment-grade
Noninvestment-grade
held by
life of assets
(in billions)
AAA to AAA-
AA+ to AA-
A+ to A-
BBB to BBB-
BB+ and below
VIEs
(years)
Nonconsolidated municipal bond
vehicles(a)
2008
$
3.8
$
5.9
$
0.2
$
0.1
$
—
$
10.0
22.3
2007
14.6
4.4
0.2
—
—
19.2
10.0
(a)
Excluded $6.0 billion and $6.9 billion at December 31, 2008 and 2007, respectively, which
were consolidated due to the Firm owning the residual interests.
(b)
Certain of the municipal bond vehicles are structured to meet the definition of a QSPE (as
discussed in Note 1 on page 122 of this Annual Report); accordingly, the assets and liabilities of
QSPEs are not reflected in the Firm’s Consolidated Balance Sheets (except for retained interests
that are reported at fair value). Excluded nonconsolidated amounts of $603 million and $7.1 billion
at December 31, 2008 and 2007, respectively, related to QSPE municipal bond vehicles in which the
Firm owned the residual interests.
(c)
The decline in balances at December 31, 2008, compared with December 31, 2007, was due to
third-party residual interest holders exercising their right to terminate the municipal bond
vehicles. The proceeds from the sales of municipal bonds were sufficient to repay the putable
floating-rate certificates, and the Firm did not incur losses as a result of these terminations.
(d)
The Firm may serve as credit enhancement provider in municipal bond vehicles in which it
serves as liquidity provider. The Firm provided insurance on underlying municipal bonds in the form
of letters of credit of $10 million and $103 million at December 31, 2008 and 2007, respectively.
(e)
Represents the excess (deficit) of municipal bond asset fair value available to repay the
liquidity facilities, if drawn.
(f)
The ratings scale is based upon the Firm’s internal risk ratings and presented on an S&P
equivalent basis.
Credit-linked note vehicles
The Firm structures transactions with credit-linked
note (“CLN”) vehicles in which the VIE purchases
highly rated assets, such as asset-backed
securities, and enters into a credit derivative
contract with the Firm to obtain exposure to a
referenced credit which the VIE otherwise does not
hold. The VIE then issues CLNs with maturities
predominantly ranging from one to ten years in
order to transfer the risk of the referenced credit
to the VIE’s investors. Clients and investors often
prefer using a CLN vehicle since the CLNs issued by
the VIE generally carry a higher credit rating than
such notes would if issued directly by JPMorgan
Chase. The Firm’s exposure to the CLN vehicles is
generally limited to its rights and obligations
under the credit derivative contract with the VIE,
as the Firm does not provide any additional
contractual financial support to the VIE. In
addition, the Firm has not historically provided
any financial support to the CLN vehicles over and
above its contractual obligations. Accordingly, the
Firm typically does
not consolidate the CLN vehicles. As a derivative
counterparty in a credit-linked note structure, the
Firm has a senior claim on the collateral of the
VIE and reports such derivatives on its balance
sheet at fair value. The collateral purchased by
such VIEs is largely investment-grade, with a
majority being rated “AAA”. The Firm divides its
credit-linked note structures broadly into two
types: static and managed.
In a static credit-linked note structure, the CLNs
and associated credit derivative contract either
reference a single credit (e.g., a multinational
corporation) or all or part of a fixed portfolio of
credits. The Firm generally buys protection from
the VIE under the credit derivative. As a net buyer
of credit protection, the Firm pays a premium to
the VIE in return for the receipt of a payment (up
to the notional amount of the derivative) if one or
more of the reference credits defaults, or if the
losses resulting from the default of the reference
credits exceed specified levels.
In a managed credit-linked note structure, the CLNs
and associated credit derivative generally
reference all or part of an actively managed
portfolio of credits. An agreement exists between a
portfolio manager and the VIE that gives the
portfolio manager the ability to substitute each
referenced credit in the portfolio for an
alternative credit. By participating in a structure
where a portfolio manager has the ability to
substitute credits within pre-agreed terms, the
investors who own the CLNs seek to reduce the risk
that any single credit in the portfolio will
default. The Firm does not act as portfolio
manager; its involvement with the VIE is generally
limited to being a derivative counterparty. As a
net buyer of credit protection, the Firm pays a
premium to the VIE in return for the receipt of a
payment (up to the notional of the derivative) if
one or more of the credits within the portfolio
defaults, or if the losses resulting from the
default of reference credits exceed specified
levels.
Exposure to nonconsolidated credit-linked note VIEs at December 31, 2008 and 2007, was as follows.
2008
2007
Par value of
Par value of
December 31,
Derivative
Trading
Total
collateral held
Derivative
Trading
Total
collateral held
(in billions)
receivables
assets(c)
exposure(d)
by VIEs(e)
receivables
assets(c)
exposure(d)
by VIEs(e)
Credit-linked notes(a)
Static structure
$
3.6
$
0.7
$
4.3
$
14.5
$
0.8
$
0.4
$
1.2
$
13.5
Managed structure(b)
7.7
0.3
8.0
16.6
4.5
0.9
5.4
12.8
Total
$
11.3
$
1.0
$
12.3
$
31.1
$
5.3
$
1.3
$
6.6
$
26.3
(a)
Excluded fair value of collateral of $2.1 billion and $2.5 billion at December 31, 2008
and 2007, respectively, which was consolidated as the Firm, in its role as secondary market maker,
held a majority of the issued CLNs of certain vehicles.
(b)
Includes synthetic collateralized debt obligation vehicles, which have similar risk
characteristics to managed credit-linked note vehicles. At December 31, 2008 and 2007, trading
assets included $7 million and $291 million, respectively, of transactions with subprime
collateral.
(c)
Trading assets principally comprise notes issued by VIEs, which from time to time are held as
part of the termination of a deal or to support limited market-making.
(d)
On-balance sheet exposure that includes derivative receivables and trading assets.
(e)
The Firm’s maximum exposure arises through the derivatives executed with the VIEs; the
exposure varies over time with changes in the fair value of the derivatives. The Firm relies upon
the collateral held by the VIEs to pay any amounts due under the derivatives; the vehicles are
structured at inception so that the par value of the collateral is expected to be sufficient to pay
amounts due under the derivative contracts.
Asset Swap Vehicles
The Firm also structures and executes transactions
with asset swap vehicles on behalf of investors. In
such transactions, the VIE purchases a specific
asset or assets and then enters into a derivative
with the Firm in order to tailor the interest rate
or currency risk, or both, of the assets according
to investors’ requirements. Generally, the assets
are held by the VIE to maturity, and the tenor of
the derivatives would match the maturity of the
assets. Investors typically invest in the notes
issued by such VIEs in order to obtain exposure to
the credit risk of the specific assets as well as
exposure to foreign exchange and interest rate risk
that is tailored to their specific needs; for example, an interest
rate derivative may add additional interest rate exposure
into the VIE in order to increase the return on the
issued notes; or to convert an interest bearing
asset into a zero-coupon bond.
The Firm’s exposure to the asset swap vehicles is
generally limited to its rights and obligations
under the interest rate and/or foreign exchange
derivative contracts, as the Firm does not provide
any contractual financial support to the VIE. In
addition, the Firm historically has not provided
any financial support to the asset swap vehicles
over and above its contractual obligations.
Accordingly, the Firm typically does not
consolidate the asset swap vehicles. As a
derivative counterparty, the Firm has a senior
claim on the collateral of the VIE and reports such
derivatives on its balance sheet at fair value.
Substantially all of the assets purchased by such
VIEs are investment-grade.
Exposure to nonconsolidated asset swap VIEs at December 31, 2008 and 2007, was as follows.
2008
2007
Par value of
Par value of
December 31,
Derivative
Trading
Total
collateral held
Derivative
Trading
Total
collateral held
(in billions)
receivables (payables)
assets(a)
exposure(b)
by VIEs(c)
receivables (payables)
assets(a)
exposure(b)
by VIEs(c)
Nonconsolidated
Asset swap vehicles(d)
$
(0.2
)
$
—
$
(0.2
)
$
7.3
$
0.2
$
—
$
0.2
$
5.6
(a)
Trading assets principally comprise notes issued by VIEs, which from time to time are held
as part of the termination of a deal or to support limited market-making.
(b)
On-balance sheet exposure that includes derivative receivables (payables) and trading assets.
(c)
The Firm’s maximum exposure arises through the derivatives executed with the VIEs; the
exposure varies over time with changes in the fair value of the derivatives. The Firm relies upon
the collateral held by the VIEs to pay any amounts due under the derivatives; the vehicles are
structured at inception so that the par value of the collateral is expected to be sufficient to pay
amounts due under the derivative contracts.
(d)
Excluded fair value of collateral of $1.0 billion and $976 million at December 31, 2008 and
2007, respectively, which was consolidated as the Firm, in its role as secondary market maker,
held a majority of the issued notes of certain vehicles.
Collateralized Debt Obligations vehicles
A CDO typically refers to a security that is
collateralized by a pool of bonds, loans, equity,
derivatives or other assets. The Firm’s involvement
with a particular CDO vehicle may take one or more
of the following forms: arranger, warehouse funding
provider, placement agent or underwriter, secondary
market-maker for securities issued, or derivative
counterparty.
Prior to the formal establishment of a CDO vehicle,
there is a warehousing period where a VIE may be
used to accumulate the assets which will be
subsequently securitized and serve as the
collateral for the securities to be issued to
investors. During this warehousing period, the Firm
may provide all or a portion of the financing to
the VIE, for which the Firm earns interest on the
amounts it finances. A third-party asset manager
that will serve as the manager for the CDO vehicle
uses the warehouse funding provided by the Firm to
purchase the financial assets. The funding
commitments generally are one year in duration. In
the event that the securitization of assets does
not occur within the committed financing period,
the warehoused assets are generally liquidated.
Because of the varied levels of support provided
by the Firm during the warehousing period, which
typically averages six to nine months, each CDO
warehouse VIE is assessed in accordance with FIN
46(R) to determine whether the Firm is considered
the primary
beneficiary that should consolidate the VIE. In
general, the Firm would consolidate the warehouse
VIE unless another third party, typically the asset
manager, provides significant protection for
potential declines in the value of the assets held
by the VIE. In those cases, the third party that
provides the protection to the warehouse VIE would
consolidate the VIE.
Once the portfolio of warehoused assets is large
enough, the VIE will issue securities where market
conditions permit. The proceeds from the issuance
of securities will be used to repay the warehouse
financing obtained from the Firm and other
counterparties. In connection with the
establishment of the CDO vehicle, the Firm
typically
earns a fee for arranging the CDO vehicle and
distributing the securities (as placement agent
and/or underwriter) and does not typically own any
equity tranches issued. Once the CDO vehicle closes
and issues securities, the Firm has no further
obligation to provide further support to the
vehicle. At the time of closing, the Firm may hold
unsold securities that the Firm was not able to
place with third-party investors. The amount of
unsold securities at December 31, 2008 and 2007,
was insignificant. In addition, the Firm may on
occasion hold some of the CDO vehicles’ securities, including
equity interests,
as a secondary market-maker or as a principal
investor, or it may be a derivative counterparty to
the vehicles. At December 31, 2008 and 2007, these
amounts were not significant. Exposures to CDO
warehouse VIEs at December 31, 2008 and 2007, were
as follows.
Typically contingent upon certain asset-quality conditions being met by asset managers.
(b)
The aggregate of the fair value of loan exposure and any unfunded, contractually committed
financing.
(c)
The ratings scale is based upon JPMorgan Chase’s internal risk ratings and presented on an S&P
equivalent basis.
VIEs sponsored by third parties
Investment in a third-party credit card securitization trust
The Firm holds a note in a third-party-sponsored
VIE, which is a credit card securitization trust
(the “Trust”), that owns credit card receivables
issued by a national retailer. The note is
structured so that the principal amount can float
up to 47% of the principal amount of the
receivables held by the Trust not to exceed $4.2
billion. The Firm is not the primary beneficiary of
the
Trust and accounts for its investment as an AFS
security, which is recorded at fair
value. At December 31, 2008, the amortized cost of
the note was $3.6 billion and the fair value was
$2.6 billion. For more information on accounting
for AFS securities, see Note 12 on pages 158–162
of this Annual Report.
VIE used in FRBNY transaction
In conjunction with the Bear Stearns merger, in
June 2008, the FRBNY took control, through an LLC
formed for this purpose, of a portfolio of $30.0
billion in assets, based upon the value of the
portfolio as of March 14, 2008. The assets of the
LLC were funded by a
$28.85 billion term loan from the FRBNY, and a
$1.15 billion subordinated loan from JPMorgan
Chase. The JPMorgan Chase loan is subordinated to
the FRBNY loan and will bear the first $1.15
billion of any losses of the portfolio. Any
remaining assets in the portfolio after repayment
of the FRBNY loan, the JPMorgan Chase loan and the
expense of the LLC, will be for the account of the
FRBNY.
Other VIEs sponsored by third parties
The Firm enters into transactions with VIEs
structured by other parties. These transactions
include, for example, acting as a derivative
counterparty, liquidity provider, investor,
underwriter, placement agent, trustee or
custodian. These transactions are conducted at
arm’s length, and individual credit decisions are
based upon the analysis of the specific VIE,
taking into consideration the quality of the
underlying assets. Where these activities do not
cause JPMorgan Chase to absorb a majority of the
expected losses of the VIEs or to receive a
majority of the residual returns of the VIEs,
JPMorgan Chase records and reports these positions
on its Consolidated Balance Sheets similar to the
way it would record and report positions from any
other third-party transaction. These transactions
are not considered significant for disclosure
purposes under FIN 46(R).
Consolidated VIE assets and liabilities
The following table presents information on assets, liabilities and commitments related to VIEs
that are consolidated by the Firm.
Excluded from total assets was $1.9 billion of unfunded commitments at December 31, 2007.
There were no unfunded commitments at December 31, 2008.
(b)
Included assets classified as resale agreements and other assets within the Consolidated
Balance Sheets.
(c)
Assets of each consolidated VIE included in the program types above are generally used to
satisfy the liabilities to third parties. The difference between total assets and total liabilities
recognized for consolidated VIEs represents the Firm’s interest in the consolidated VIEs for each
program type.
(d)
The interest-bearing beneficial interest liabilities issued by consolidated VIEs are classified
in the line item titled, “Beneficial interests issued by consolidated variable interest entities”
on the Consolidated Balance Sheets. The holders of these beneficial interests do not have recourse
to the general credit of JPMorgan Chase. Included in beneficial interests in VIE assets are
long-term beneficial interests of $5.0 billion and $7.2 billion at December 31, 2008 and 2007,
respectively. See Note 23 on page 191 of this Annual Report for the maturity profile of FIN 46
long-term beneficial interests.
(e)
Included liabilities classified as other borrowed funds, long-term debt and other liabilities
in the Consolidated Balance Sheets.
Note 18
– Goodwill and other intangible assets
Goodwill is not amortized. Instead, it is
tested for impairment in accordance with SFAS 142
at the reporting-unit segment, which is generally
one level below the six major reportable business
segments (as described in Note 37 on pages 214–215
of this Annual Report); plus Private Equity (which
is included in Corporate). Goodwill is tested
annually (during the fourth quarter) or more often
if events or circumstances, such as adverse changes
in the business climate, indicate there may be
impairment. Management applies significant judgment
when determining the fair value of its reporting
units.
Imprecision in estimating the future earnings
potential of the Firm’s reporting units can affect
their estimated fair value. In addition, if the
current period of weak economic market conditions
persists, then this could adversely impact the
estimates management used to determine the fair
value of its reporting units. Intangible assets
determined
to have indefinite lives are not amortized
but are
tested for impairment at least annually, or more
frequently if events or changes in circumstances
indicate that the asset might be impaired. The
impairment test compares the fair value of the
indefinite-lived intangible asset to its carrying
amount. Other acquired intangible assets determined
to have finite lives, such as core deposits and
credit card relationships, are amortized over their
estimated useful lives in a manner that best
reflects the economic benefits of the intangible
asset; impairment testing is performed periodically
on these amortizing intangible assets.
Goodwill and other intangible assets consist of the following.
December 31, (in millions)
2008
2007
Goodwill
$
48,027
$
45,270
Mortgage servicing rights
9,403
8,632
Purchased credit card relationships
1,649
2,303
All other intangibles:
Other credit
card–related intangibles
$
743
$
346
Core deposit intangibles
1,597
2,067
Other intangibles
1,592
1,383
Total all other intangible assets
$
3,932
$
3,796
Goodwill
The $2.8 billion increase in goodwill from the
prior year primarily resulted from the dissolution
of the Chase Paymentech Solutions joint venture, the
merger with Bear Stearns, the purchase of an
additional equity interest in Highbridge and the
tax-related purchase accounting adjustments
associated with the Bank One merger, which
increased goodwill attributed to IB. The
decrease in goodwill attributed to TSS
predominantly resulted from the sale of a
previously consolidated subsidiary. For additional
information see Note 2 on pages 123–128 of this
Annual Report.
Goodwill was not impaired at December 31, 2008, or
2007, nor was any goodwill written off due to
impairment during 2008 and 2007.
Goodwill attributed to the business segments was as follows.
December 31, (in millions)
2008
2007
Investment Bank
$
4,765
$
3,578
Retail Financial Services
16,840
16,848
Card Services
13,977
12,810
Commercial Banking
2,870
2,873
Treasury & Securities Services
1,633
1,660
Asset Management
7,565
7,124
Corporate/Private Equity
377
377
Total goodwill
$
48,027
$
45,270
Mortgage servicing rights
JPMorgan Chase recognizes as intangible assets
mortgage servicing rights, which represent the
right to
perform specified mortgage servicing activities
(predominantly with respect to residential
mortgages) for others. MSRs are either purchased
from third parties or retained upon sale or
securitization of mortgage loans. Servicing
activities include collecting principal, interest,
and escrow payments from borrowers; making tax and
insurance payments on behalf of borrowers;
monitoring delinquencies and executing foreclosure
proceedings; and accounting for and remitting
principal and interest payments to the investors of
the mortgage-backed securities.
As
permitted by SFAS 156, the Firm elected to fair value MSRs as
one class of servicing assets. The Firm defined MSRs as one class
based on the availability of market inputs to measure MSR fair value
and its treatment of MSRs as one aggregate pool for risk management
purposes.
The Firm initially capitalizes MSRs based on the
estimated fair value at the time of initial
recognition. The Firm estimates the fair value of
MSRs for initial capitalization and ongoing
valuation using an option-adjusted spread model,
which projects MSR cash flows over multiple
interest rate scenarios in conjunction with the
Firm’s proprietary prepayment model and then
discounts these cash flows at risk-adjusted rates.
The model considers portfolio characteristics,
contractually specified servicing fees, prepayment
assumptions, delinquency rates, late charges, other
ancillary revenue and costs to service, and other
economic factors. The Firm reassesses and
periodically adjusts the underlying inputs and
assumptions used in the OAS model to reflect market
conditions and assumptions that a market
participant would consider in valuing the MSR
asset. During 2007 and 2008, the Firm continued to
refine its proprietary payment model based upon a
number of market-related factors, including a
downward trend in home prices, general tightening
of credit underwriting standards and the associated
impact on refinancing activity. The Firm compares
fair value estimates and assumptions to observable
market data where available and to recent market
activity and actual portfolio experience.
The fair value of MSRs is sensitive to changes in
interest rates, including their effect on
prepayment speeds. JPMorgan Chase uses or has used
combinations of derivatives and trading instruments
to manage changes in the fair value of MSRs. The
intent is to offset any changes in the fair value
of MSRs with changes in the fair value of the
related risk management instruments. MSRs decrease
in value when interest rates decline. Conversely,
securities (such as mortgage-backed securities),
principal-only certificates and certain derivatives
(when the Firm receives fixed-rate interest
payments) increase in value when interest rates
decline.
Balance at beginning of period after
valuation allowance
$
8,632
$
7,546
$
6,452
Cumulative effect of change in
accounting principle
—
—
230
Fair value at beginning of period
8,632
7,546
6,682
MSR activity
Originations of MSRs
3,061
2,335
1,512
Purchase of MSRs
6,755
(c)
798
627
Total additions
9,816
3,133
2,139
Change in valuation due to inputs
and assumptions(a)
(6,933
)
(516
)
165
Other changes in fair value(b)
(2,112
)
(1,531
)
(1,440
)
Total change in fair value of MSRs
(9,045
)(d)
(2,047
)
(1,275
)
Fair value at December 31
$
9,403
$
8,632
$
7,546
Change in unrealized gains (losses)
included in income related to MSRs
held at December 31
$
(6,933
)
$
(516
)
NA
Contractual service fees, late fees
and other ancillary fees included
in income
$
3,353
$
2,429
$
2,038
Third-party mortgage loans
serviced at December 31, (in billions)
$
1,185.0
$
614.7
$
526.7
(a)
Represents MSR asset fair value adjustments due to changes in inputs, such as
interest rates and volatility, as well as updates to assumptions used in the valuation
model. This caption also represents total realized and unrealized gains (losses) included
in net income per the SFAS 157 disclosure for fair value measurement using significant
unobservable inputs (level 3).
(b)
Includes changes in the MSR value due to modeled servicing portfolio runoff (or
time decay). This caption represents the impact of cash settlements per the SFAS
157 disclosure for fair value measurement using significant unobservable inputs (level 3).
(c)
Includes MSRs acquired as a result of the Washington Mutual
transaction (of which, $59
million related to commercial real estate) and the Bear Stearns merger. For further
discussion, see Note 2 on pages 123–128 of this Annual Report.
(d)
Includes $4 million related to commercial real estate.
The table below outlines the key economic
assumptions used to determine the fair value of the
Firm’s MSRs at December 31, 2008 and 2007,
respectively; and it outlines the sensitivities of
those fair values to immediate 10% and 20% adverse
changes in those assumptions.
Impact on fair value of 100 basis points
adverse change
$
(311
)
$
(311
)
Impact on fair value of 200 basis points
adverse change
(606
)
(599
)
CPR:
Constant prepayment rate.
The sensitivity analysis in the preceding table
is hypothetical and should be used with caution.
Changes in fair value based upon a 10% and 20%
variation in assumptions generally cannot be easily
extrapolated because the relationship of the change
in the assumptions to the change in fair value may
not be linear. Also, in this table, the effect that
a change in a particular assumption may have on the
fair value is calculated without changing any other
assumption. In reality, changes in one factor may
result in changes in another, which might magnify
or counteract the sensitivities.
Purchased credit card relationships and
all other intangible assets
During 2008, purchased credit card relationships,
other credit card-related intangibles and core
deposit intangibles decreased $727 million,
primarily as a result of amortization expense,
partially offset by an increase in intangibles
recognized related to the dissolution of the Chase
Paymentech Solutions joint venture. Other
intangibles (net of amortization) increased $209
million primarily as a result of the purchase of an
additional equity interest in Highbridge as well as
the acquisition of an institutional global custody
portfolio.
Except for $517 million of indefinite-lived
intangibles related to asset management advisory
contracts, which are not amortized but are tested
for impairment at least annually, the remainder of
the Firm’s other acquired intangible assets are
subject to amortization.
The components of credit card relationships, core deposits and other intangible assets were as
follows.
2008
2007
Net
Net
Gross
Accumulated
carrying
Gross
Accumulated
carrying
December 31, (in millions)
amount
amortization
value
amount
amortization
value
Purchased credit card relationships
$
5,765
$
4,116
$
1,649
$
5,794
$
3,491
$
2,303
All other intangibles:
Other credit
card-related intangibles
$
852
$
109
$
743
$
422
$
76
$
346
Core deposit intangibles
4,280
2,683
1,597
4,281
2,214
2,067
Other intangibles
2,376
784
(a)
1,592
2,026
643
(a)
1,383
(a)
Includes amortization expense related to servicing assets on securitized
automobile loans, which is recorded in lending & deposit-related fees, of $5 million and
$9 million for the years ended December 31, 2008 and 2007, respectively.
Amortization expense
The following table presents amortization expense related to credit card relationships, core
deposits and all other intangible assets.
Year ended December 31, (in millions)
2008
2007
2006
Purchased credit card relationships
$
625
$
710
$
731
All other intangibles:
Other credit
card-related intangibles
33
11
6
Core deposit intangibles
469
554
568
Other intangibles
136
119
123
(a)
Total amortization expense
$
1,263
$
1,394
$
1,428
(a)
Amortization expense related to the aforementioned selected
corporate trust businesses were reported in income from discontinued
operations for 2006.
Future amortization expense
The following table presents estimated future amortization expense related to credit card
relationships, core deposits and all other intangible assets at December 31, 2008.
Other credit
Purchased credit
card-related
Core deposit
All other
Year ended December 31, (in millions)
card relationships
intangibles
intangibles
intangible assets
Total
2009
$
419
$
93
$
390
$
123
$
1,025
2010
350
98
329
106
883
2011
287
97
285
96
765
2012
249
98
239
93
679
2013
210
97
196
90
593
Note 19
– Premises and equipment
Premises and equipment, including leasehold
improvements, are carried at cost less accumulated
depreciation and amortization. JPMorgan Chase
computes depreciation using the straight-line
method over the estimated useful life of an asset.
For leasehold improvements, the Firm uses the
straight-line method computed over the lesser of
the remaining term of the leased facility or the
estimated useful life of the leased asset. JPMorgan
Chase has recorded
immaterial asset retirement obligations related to
asbestos remediation under SFAS 143 and FIN 47 in
those cases where it has sufficient information to
estimate the obligations’ fair value.
JPMorgan Chase capitalizes certain costs associated
with the acquisition or development of internal-use
software under SOP 98-1. Once the software is ready
for its intended use, these costs are amortized on
a straight-line basis over the software’s expected
useful life and reviewed for impairment on an
ongoing basis.
On October 3, 2008, the Emergency Economic
Stabilization Act of 2008 was signed into law. The
Act increased FDIC deposit insurance from $100,000
to $250,000 per depositor through December 31,2009. In addition, on November 21, 2008, the FDIC
released the Final Rule for the FDIC Temporary
Liquidity Guarantee Program (“TLG Program”), which
provides unlimited deposit insurance through
December 31, 2009, for noninterest-bearing
transaction deposit accounts at FDIC-insured
participating institutions. The Firm elected to
continue to participate in the TLG Program and, as
a result, will be required to pay additional
insurance premiums to the FDIC in an amount equal
to an
annualized 10-basis points on balances in
noninterest-bearing transaction accounts that
exceed the $250,000 FDIC deposit insurance limits,
as determined on a quarterly basis.
Note
21 – Other borrowed funds
The following table details the components of other borrowed funds.
December 31, (in millions)
2008
2007
Advances from Federal Home Loan Banks(a)
$
70,187
$
450
Nonrecourse
advances – FRBB(b)
11,192
—
Other
51,021
(c)
28,385
Total
$
132,400
$
28,835
(a)
Maturities of advances from the Federal Home Loan Banks were $47.4 billion, $18.5
billion, $2.6 billion, and $714 million in each of the 12-month periods ending December31, 2009, 2010, 2011, and 2013, respectively, and $1.0 billion maturing after December 31,2013. Maturities for the 12-month period ending December 31, 2012 were not material.
(b)
On September 19, 2008, the Federal Reserve Board established a temporary lending
facility, the AML Facility, to provide liquidity to eligible U.S. money market mutual
funds (“MMMFs”). Under the AML Facility, banking organizations must use the loan proceeds
to finance their purchases of eligible high-quality asset-backed commercial paper (“ABCP”)
investments from MMMFs, which are pledged to secure nonrecourse advances from the Federal
Reserve Bank of Boston (“FRBB”). Participating banking organizations do not bear any
credit or market risk related to the ABCP investments they hold under this facility;
therefore, the ABCP investments held are not assessed any regulatory capital. The AML
Facility will be in effect until October 30, 2009. The nonrecourse advances from the FRBB
were elected under the fair value option and recorded in other borrowed funds; the
corresponding ABCP investments were also elected under the fair value option and recorded
in other assets.
(c)
Includes $30.0 billion of advances from the Federal Reserve under the Federal
Reserve’s Term Auction Facility (“TAF”), pursuant to which the Federal Reserve auctions
term funds to depository institutions that are eligible to borrow under the primary credit
program. The TAF allows all eligible depository institutions to place a bid for an advance
from its local Federal Reserve Bank at an interest rate set by an auction. All advances
are required to be fully collateralized. The TAF is designed to improve liquidity by
making it easier for sound institutions to borrow when the markets are not operating
efficiently. The TAF does not have a fixed expiration date.
Note
22 – Accounts payable and other liabilities
The following table details the components of
accounts payable and other liabilities at each of
the dates indicated.
December 31, (in millions)
2008
2007
Accounts payable and other liabilities:
Accounts payable
$
48,019
$
39,785
Brokerage payables(a)
88,585
14,612
Other liabilities
51,374
40,079
Total
$
187,978
$
94,476
(a)
Includes payables to customers, brokers, dealers and clearing organizations, and
securities fails.
JPMorgan Chase issues long-term debt denominated in various currencies, although predominantly
U.S. dollars, with both fixed and variable interest rates. The following table is a summary of
long-term debt carrying values (including unamortized original issue discount, SFAS 133 valuation
adjustments and fair value adjustments, where applicable) by contractual maturity as of December31, 2008.
Included are various equity-linked or other indexed instruments. Embedded derivatives,
separated from hybrid securities in accordance with SFAS 133, are reported at fair value
and shown net with the host contract on the Consolidated Balance Sheets. Changes in fair
value of separated derivatives are recorded in principal transactions revenue. Hybrid
securities which the Firm has elected to measure at fair value are classified in the line
item of the host contract on the Consolidated Balance Sheets; changes in fair value are
recorded in principal transactions revenue in the Consolidated Statements of Income.
(b)
The interest rates shown are the range of contractual rates in effect at year-end,
including non U.S. dollar fixed- and variable-rate issuances, which excludes the effects of
the associated derivative instruments used in SFAS 133 hedge accounting relationships, if
applicable. The use of these derivative instruments modifies the Firm’s exposure to the
contractual interest rates disclosed in the table above. Including the effects of the SFAS
133 hedge accounting derivatives, the range of modified rates in effect at December 31,2008, for total long-term debt was 0.18% to 14.21%, versus the contractual range of 0.03%
to 14.21% presented in the table above. The interest rate ranges shown exclude structured
notes accounted for at fair value under SFAS 155 or SFAS 159.
(c)
Included $7.8 billion principal amount of U.S. dollar-denominated floating-rate
mortgage bonds issued to an unaffiliated statutory trust, which in turn issued €6.0
billion in covered bonds secured by mortgage loans at December 31, 2008.
(d)
Included $58.2 billion and $70.5 billion of outstanding structured notes accounted
for at fair value at December 31, 2008 and 2007, respectively.
(e)
Included on the Consolidated Balance Sheets in beneficial interests issued by
consolidated VIEs. Also included $1.7 billion and $3.0 billion of outstanding structured
notes accounted for at fair value at December 31, 2008 and 2007, respectively.
(f)
Included $14.1 billion as of December 31, 2008, guaranteed under the TLG Program
whereby newly issued senior, unsecured debt is guaranteed by the FDIC, which is discussed
below.
(g)
Included $6.9 billion as of December 31, 2008, guaranteed by the FDIC under the TLG
Program, which is discussed below.
(h)
At December 31, 2008, long-term debt aggregating $7.4 billion was redeemable at the
option of JPMorgan Chase, in whole or in part, prior to maturity, based upon the terms
specified in the respective notes.
(i)
The aggregate principal amount of debt that matures in each of the five years
subsequent to 2008 is $36.0 billion in 2009, $38.5 billion in 2010, $39.7 billion in 2011,
$32.7 billion in 2012 and $18.6 billion in 2013.
(j)
Included $3.4 billion and $4.6 billion of outstanding zero-coupon notes at December31, 2008 and 2007, respectively. The aggregate principal amount of these notes at their
respective maturities was $7.1 billion and $7.7 billion, respectively.
The weighted-average contractual interest rate
for total long-term debt was 4.06% and 5.20% as of
December 31, 2008 and 2007, respectively. In order
to modify
exposure to interest rate and currency exchange
rate movements, JPMorgan Chase utilizes derivative
instruments, primarily interest rate and
cross-currency interest rate swaps, in conjunction
with some of its debt issues. The use of these
instruments modifies the Firm’s interest expense on
the associated debt. The modified weighted-average
interest rate for total long-term debt, including
the effects of related derivative instruments, was
3.53% and 5.13% as of December 31, 2008 and 2007,
respectively.
JPMorgan Chase has elected to continue to
participate in the TLG Program, which is available
to, among others, all U.S. depository institutions
insured by the FDIC and all U.S. bank holding
companies, unless they have opted out of the TLG
Program or the FDIC has terminated their
participation. Under the TLG Program, the FDIC
guarantees certain senior unsecured debt of
JPMorgan Chase through the earlier of maturity and June 30, 2012, and in return for the guarantees,
the FDIC is paid a fee based on the amount and
maturity of the debt. Under the TLG Program, the
FDIC will pay the unpaid principal and interest on
an FDIC-guaranteed
debt instrument upon the uncured failure of
the participating entity to make a timely payment
of principal or interest in accordance with the
terms of the instrument. The guarantee of new obligations under the TLG Program is
scheduled to expire in October 2009.
JPMorgan Chase & Co. (Parent Company) has
guaranteed certain debt of its subsidiaries,
including both long-term debt and structured notes
sold as part of the Firm’s market-making
activities. These guarantees rank on a parity with
all of the Firm’s other unsecured and
unsubordinated indebtedness. Guaranteed liabilities
totaled $4.8 billion and $4.7 billion at December31, 2008 and 2007, respectively. For additional
information, see Note 2 on pages 123–128 of this
Annual Report.
Junior subordinated deferrable interest debentures
held by trusts that issued guaranteed capital debt
securities
At December 31, 2008, the Firm had established 24
wholly-owned Delaware statutory business trusts
(“issuer trusts”) that had issued guaranteed
capital debt securities.
The junior subordinated deferrable interest
debentures issued by the Firm to the issuer trusts,
totaling $18.6 billion and $15.1 billion at
December 31, 2008 and 2007, respectively, were
reflected in the Firm’s Consolidated Balance Sheets
in the liabilities section under the caption
“Junior subordinated deferrable interest debentures
held by trusts that issued guaranteed capital debt
securities” (i.e., trust preferred capital debt
securities). The Firm also records the common
capital securities issued by the issuer trusts in
other assets in its Consolidated Balance Sheets at
December 31, 2008 and 2007.
The debentures issued to the issuer trusts by the
Firm, less the common capital securities of the
issuer trusts, qualify as Tier 1 capital. The
following is a summary of the outstanding trust
preferred capital debt securities, including
unamortized original issue discount, issued by each
trust, and the junior subordinated deferrable
interest debenture issued to each trust as of
December 31, 2008.
Represents the amount of capital securities issued to the public by each trust,
including unamortized original issue discount.
(b)
Represents the principal amount of JPMorgan Chase debentures issued to each trust,
including unamortized original issue discount. The principal amount of debentures issued
to the trusts includes the impact of hedging and purchase accounting fair value
adjustments that were recorded on the Firm’s Consolidated Financial Statements.
(c)
Subject to Series K Preferred Stock restrictions, which are discussed in Note 24
below.
JPMorgan Chase is authorized to issue 200
million shares of preferred stock, in one or more
series, with a par value of $1 per share.
On April 23, 2008, the Firm issued 600,000
shares of Fixed to Floating Rate Noncumulative
Perpetual Preferred Stock, Series I (“Series
I”).
On July 15, 2008, each series of Bear Stearns
preferred stock then issued and outstanding was
exchanged into a series of JPMorgan Chase
preferred stock
(Cumulative Preferred Stock, Series E, Series F
and Series G) having substantially identical
terms. As a result of the exchange, these
preferred shares rank equally with the other
series of the Firm’s preferred stock.
On August 21, 2008, the Firm issued 180,000
shares of 8.625% Noncumulative Perpetual
Preferred Stock, Series J (“Series J”).
On October 28, 2008, pursuant to the U.S.
Department of the Treasury’s (the “U.S. Treasury”)
Capital Purchase Program (the “Capital Purchase
Program”), the Firm issued to the U.S. Treasury, in
exchange for total proceeds of $25.0 billion, (i)
2.5 million shares of the Firm’s Fixed Rate
Cumulative Perpetual Preferred Stock, Series K, par
value $1 per share and liquidation preference
$10,000 per share (the “Series K Preferred Stock”),
and (ii) a warrant to purchase 88,401,697 shares of
the Firm’s common stock at an exercise price
of $42.42 per share (the “Warrant”). The $25.0
billion proceeds were allocated to the Series K
Preferred Stock and the Warrant based on the
relative fair value of the instruments. The
difference between the initial carrying value of
$23.7 billion that was allocated to the Series K
Preferred Stock and its redemption value of $25.0
billion will be charged to retained earnings (with
a corresponding increase in the carrying value of
the Series K Preferred Stock) over the first five
years of the contract as an adjustment to the
dividend yield using the effective yield method.
The Series K Preferred Stock is non-voting,
qualifies as Tier 1 capital and ranks equally with
the Firm’s other series of preferred stock.
In the event of a liquidation or dissolution of
the Firm, JPMorgan Chase’s preferred stock then
outstanding takes precedence over the Firm’s
common stock for the payment of dividends and the
distribution of assets.
Generally, dividends on shares of outstanding
series of preferred stock are payable quarterly.
Dividends on the shares of Series I preferred stock
are payable semiannually at a fixed annual dividend
rate of 7.90% through April 2018, and then become
payable quarterly at an annual dividend rate of
three-month LIBOR plus 3.47%.
Dividends are payable quarterly on the Series K
Preferred Stock at a fixed annual dividend rate of
5% for the first five years, and a fixed annual
dividend rate of 9% thereafter. The effective
dividend yield of Series K Preferred stock is
6.16%.
The following is a summary of JPMorgan Chase preferred stock outstanding as of December 31, 2008.
There was no preferred stock outstanding at December 31, 2007.
Fixed to Floating Rate Noncumulative
Perpetual Preferred Stock, Series I(a)
10,000
600,000
6,000
4/30/2018
7.90
Noncumulative Perpetual Preferred
Stock, Series J(a)
10,000
180,000
1,800
9/1/2013
8.63
Fixed Rate Cumulative Perpetual
Preferred Stock, Series K
10,000
2,500,000
23,787
(c)
12/1/2011
(e)
5.00
Total preferred stock
5,038,107
$
31,939
(a)
Represented by depositary shares.
(b)
Redemption price includes amount shown in the table plus any accrued but unpaid
dividends.
(c)
Represents the carrying value as of December 31, 2008. The redemption value is $25.0
billion.
(d)
Subject to Series K Preferred Stock restrictions, which are discussed below.
(e)
Generally, the Firm may not redeem Series K Preferred Stock prior to the first
dividend payment date falling on or after October 28, 2011. However, prior to this date,
the Firm may redeem the securities up to the amount of the aggregate gross proceeds from a
“qualified equity offering” if it has received aggregate gross proceeds from such
offerings above an amount agreed with the U.S. Treasury and received approval from the
applicable federal banking agencies.
Series K Preferred Stock Dividend restrictions
For as long as any shares of Series K Preferred
Stock are outstanding, no dividends may be declared
or paid on stock ranking junior or equally with the
Series K Preferred Stock, unless all accrued and
unpaid dividends for all past dividend periods on
the Series K Preferred Stock are fully paid. Pursuant to the Capital Purchase Program, until October 28, 2011, the U.S. Treasury’s
consent is required for any increase in dividends on the Firm’s common stock from the amount of the last
quarterly stock dividend declared by the Firm prior to October 14, 2008, unless the Series K Preferred Stock is
redeemed in whole before then, or the U.S. Treasury has transferred all of the Series K Preferred Stock it owns to third parties.
Stock repurchase restrictions
The Firm may not repurchase or redeem any common
stock or other equity securities of the Firm, or
any trust preferred capital debt securities issued
by the Firm or any of its affiliates, without the
prior consent of the U.S. Treasury (other than (i)
repurchases of the Series K Preferred Stock and
(ii) repurchases of junior preferred shares or
common stock in connection with any employee
benefit plan in the ordinary course of business
consistent with past practice) until October 28,2011, unless the Series K Preferred Stock is
redeemed in whole before then, or the U.S. Treasury
has transferred all of the Series K Preferred Stock
it owns to third parties.
Note
25 – Common stock
At December 31, 2008, JPMorgan Chase was
authorized to issue 9.0 billion shares of common
stock with a $1 par value per share.
On September 30, 2008, the Firm issued $11.5
billion of new shares of common stock at $40.50 per
share, representing 284 million shares.
On April 8, 2008, pursuant to the Share Exchange
Agreement dated March 24, 2008, between JPMorgan
Chase and Bear Stearns, 20.7 million newly issued
shares of JPMorgan Chase common stock were issued
to Bear Stearns in a transaction that was exempt
from registration under the Securities Act of 1933,
pursuant to Section 4(2) thereof, in exchange for
95.0 million newly issued shares of Bear Stearns
common stock (or 39.5% of Bear Stearns common stock
after giving effect to the issuance). Upon the
consummation of the Bear Stearns merger, on May 30,2008, the 20.7 million shares of JPMorgan Chase
common stock and 95 million shares of Bear Stearns
common stock were cancelled. For a further
discussion of this transaction, see Note 2 on pages
123–128 of this Annual Report.
Common shares issued (newly issued or distributed
from treasury) by JPMorgan Chase during 2008, 2007
and 2006 were as follows.
December 31, (in millions)
2008
2007
2006
Issued – balance at January 1
3,657.7
3,657.8
3,618.2
Newly issued:
Common stock:
Open market issuance
283.9
—
—
Bear Stearns Share Exchange Agreement
20.7
—
—
Employee benefits and compensation plans
—
—
39.3
Employee stock purchase plans
—
—
0.6
Total newly issued
304.6
—
39.9
Canceled shares
(20.7
)
(0.1
)
(0.3
)
Total
issued – balance at
December 31
3,941.6
3,657.7
3,657.8
Treasury
– balance at January 1
(290.3
)
(196.1
)
(131.5
)
Purchases of treasury stock
—
(168.2
)
(90.7
)
Share repurchases related to employee
stock-based awards(a)
(0.5
)
(2.7
)
(8.8
)
Issued from treasury:
Change from the Bear Stearns merger
as a result of the reissuance of
Treasury stock and the Share
Exchange Agreement
26.5
—
—
Employee benefits and
compensation plans
54.4
75.7
34.4
Employee stock purchase plans
1.1
1.0
0.5
Total issued from treasury
82.0
76.7
34.9
Total
treasury – balance at
December 31
(208.8
)
(290.3
)
(196.1
)
Outstanding
3,732.8
3,367.4
3,461.7
(a)
Participants in the Firm’s stock-based incentive plans may have shares withheld to
cover income taxes. The shares withheld amounted to 0.5 million, 2.7 million and 8.1
million for 2008, 2007 and 2006, respectively.
Pursuant to the Capital Purchase Program, the
Firm issued to the U.S. Treasury a Warrant to
purchase up to 88,401,697 shares of the Firm’s
common stock at an exercise price of $42.42 per
share. Based upon its fair value relative to the
Series K Preferred Stock as discussed in Note 24 on
pages 193–194 of this Annual Report, the Warrant
was recorded in capital surplus at a value of $1.3
billion and is accounted for as equity. The Warrant
is exercisable, in whole or in part, at any time and
from time to time until the tenth anniversary of
the issue date.
During the year ended December 31, 2008, the
Firm did not repurchase any shares of common stock.
During 2007 and 2006, the Firm repurchased 168
million shares and 91 million shares, respectively,
of common stock under stock repurchase programs
approved by the Board of Directors.
The Board of Directors approved in April 2007, a
stock repurchase program that authorizes the
repurchase of up to $10.0 billion of the Firm’s
common shares, which superseded an $8.0 billion
stock repurchase program approved in 2006. The
$10.0 billion authorization includes shares to be
repurchased to offset issuances under the Firm’s
employee stock-based plans. The actual number of
shares that may be repurchased is subject to
various factors, including market conditions; legal
considerations affecting the amount and timing of
repurchase activity; the Firm’s capital position
(taking into account goodwill and intangibles);
internal capital generation; and alternative
potential investment opportunities. The repurchase
program does not include specific price targets or
timetables; may be executed through open market
purchases or privately negotiated transactions, or
utilizing Rule 10b5-1 programs; and may be
suspended at any time. A Rule 10b5-1 repurchase
plan allows the Firm to repurchase shares during
periods when it would not otherwise be repurchasing
common stock – for example, during internal
trading “black-out periods.” All purchases under a
Rule 10b5-1 plan must be made according to a
predefined plan that is established when the Firm
is not aware of material nonpublic information.
For a discussion of restrictions on the Firm’s
ability to repurchase the Firm’s common stock, see
Note 24 above.
As of December 31, 2008, approximately 524 million
unissued shares of common stock were reserved for
issuance under various employee incentive,
compensation, option and stock purchase plans,
director compensation plans and the Warrant issued
to the U.S. Treasury under the Capital Purchase
Program as discussed above.
Note
26 – Earnings per share
SFAS 128 requires the presentation of basic and
diluted earnings per share (“EPS”) in the
Consolidated Statements of Income. Basic EPS is
computed by dividing net income applicable to
common stock by the weighted-average number of
common shares outstanding for the period. Diluted
EPS is computed using the same method for the
numerator as basic EPS but, in the denominator, the
number of common shares reflect, in addition to
outstanding shares, the potential dilution that
could occur if convertible securities or other
contracts to issue common stock were converted or
exercised into common stock. Net income available
for
common stock is the same for basic EPS and diluted
EPS, as JPMorgan Chase had no convertible
securities, and therefore, no adjustments to net
income applicable to common stock were necessary.
The following table presents the calculation of
basic and diluted EPS for 2008, 2007 and 2006.
Year ended December 31,
(in millions, except per share amounts)
2008
2007
2006
Basic earnings per share
Income from continuing operations
$
3,699
$
15,365
$
13,649
Income from discontinued operations
—
—
795
Income before extraordinary gain
$
3,699
$
15,365
$
14,444
Extraordinary gain
1,906
—
—
Net income
5,605
15,365
14,444
Less: preferred stock dividends
674
—
4
Net income applicable to
common stock
$
4,931
$
15,365
$
14,440
Weighted-average basic
shares outstanding
3,501
3,404
3,470
Income from continuing
operations per share
$
0.86
$
4.51
$
3.93
Discontinued operations per share
—
—
0.23
Extraordinary gain per share
0.55
—
—
Net income per share
$
1.41
$
4.51
$
4.16
Year ended December 31,
(in millions, except per share amounts)
2008
2007
2006
Diluted earnings per share
Net income applicable to
common stock
$
4,931
$
15,365
$
14,440
Weighted-average basic
shares outstanding
3,501
3,404
3,470
Add: Employee restricted stock,
RSUs, stock options and SARs
104
104
104
Weighted-average diluted
shares outstanding(a)
3,605
3,508
3,574
Income from continuing
operations per share
$
0.84
$
4.38
$
3.82
Discontinued operations per share
—
—
0.22
Extraordinary gain per share
0.53
—
—
Net income per share
$
1.37
$
4.38
$
4.04
(a)
Options issued under employee benefit plans and, in 2008, the warrant issued under
the U.S. Treasury’s Capital Purchase Program to purchase an aggregate 209 million, 129
million and 150 million shares of common stock were outstanding for the years ended
December 31, 2008, 2007 and 2006, respectively, but were not included in the computation
of diluted EPS, because the options and warrant were antidilutive.
Note
27 – Accumulated other comprehensive income (loss)
Accumulated other comprehensive income (loss) includes the after-tax change in unrealized gains
and losses on AFS securities, SFAS 52 foreign currency translation adjustments (including the
impact of related derivatives), SFAS 133 cash flow hedging activities and SFAS 158 net loss and
prior service cost (credit) related to the Firm’s defined benefit pension and OPEB plans.
Represents the after-tax difference between the fair value and amortized cost of
the AFS securities portfolio and retained interests in securitizations recorded in other
assets.
(b)
The net change during 2006 was due primarily to the reversal of unrealized losses
from securities sales.
(c)
The net change during 2007 was due primarily to a decline in interest rates.
(d)
The net change during 2008 was due primarily to spread widening in credit card
asset-backed securities, non-agency mortgage-backed securities and collateralized loan
obligations.
(e)
For further discussion of SFAS 158, see Note 9 on pages
149–155 of this Annual
Report.
The following table presents the after-tax changes in net unrealized gains (losses); and
reclassification adjustments for realized (gains) losses on AFS securities and cash flow hedges;
changes resulting from foreign currency translation adjustments (including the impact of related
derivatives); net gains (losses) and prior service costs from pension and OPEB plans; and
amortization of pension and OPEB amounts into net income. The table also reflects the adjustment to
accumulated other comprehensive income (loss) resulting from the initial application of SFAS 158 to
the Firm’s defined benefit pension and OPEB plans. Reclassification adjustments include amounts
recognized in net income that had been recorded previously in other comprehensive income (loss).
Net unrealized gains (losses) arising during
the period
$
(3,071
)
$
1,171
$
(1,900
)
$
759
$
(310
)
$
449
$
(403
)
$
144
$
(259
)
Reclassification adjustment for realized (gains)
losses included in net income
(965
)
384
(581
)
(164
)
67
(97
)
797
(285
)
512
Net change
(4,036
)
1,555
(2,481
)
595
(243
)
352
394
(141
)
253
Translation adjustments:
Translation
(1,781
)
682
(1,099
)
754
(281
)
473
590
(236
)
354
Hedges
820
(327
)
493
(780
)
310
(470
)
(563
)
222
(341
)
Net change
(961
)
355
(606
)
(26
)
29
3
27
(14
)
13
Cash flow hedges:
Net unrealized gains (losses) arising during
the period
584
(226
)
358
(737
)
294
(443
)
(250
)
98
(152
)
Reclassification adjustment for realized (gains)
losses
included in net income
402
(160
)
242
217
(87
)
130
93
(36
)
57
Net change
986
(386
)
600
(520
)
207
(313
)
(157
)
62
(95
)
Net loss and prior service cost (credit) of defined
benefit pension and OPEB plans:(a)
Net gains (losses) and prior service credits arising
during the period
(3,579
)
1,289
(2,290
)
934
(372
)
562
NA
NA
NA
Reclassification adjustment for net loss and prior
service
credit included in net income
14
(7
)
7
59
(22
)
37
NA
NA
NA
Net change
(3,565
)
1,282
(2,283
)
993
(394
)
599
NA
NA
NA
Total other comprehensive income (loss)
$
(7,576
)
$
2,806
$
(4,770
)
$
1,042
$
(401
)
$
641
$
264
$
(93
)
$
171
Net loss and prior service cost (credit) of defined
benefit pension and OPEB plans:
Adjustments to initially apply SFAS 158(a)
NA
NA
NA
NA
NA
NA
$
(1,746
)
$
644
$
(1,102
)
(a)
For further discussion of SFAS 158 and details of changes to accumulated other
comprehensive income (loss), see Note 9 on pages 149–155 of this Annual Report.
Note 28
– Income taxes
JPMorgan Chase and eligible subsidiaries file a
consolidated U.S. federal income tax return.
JPMorgan Chase uses the asset-and-liability method
required by SFAS 109 as amended by FIN 48 to
provide income taxes on all transactions recorded
in the consolidated financial statements. This
method requires that income taxes reflect the
expected future tax consequences of temporary
differences between the carrying amounts of assets
or liabilities for book and tax purposes.
Accordingly, a deferred tax liability or asset for
each temporary difference is determined based upon
the tax rates that the Firm expects to be in effect
when the underlying items of income and expense are
realized. JPMorgan Chase’s expense for income taxes
includes the current and deferred portions of that
expense. A valuation allowance is established to
reduce deferred tax assets to the amount the Firm
expects to realize.
Due to the inherent complexities arising from the
nature of the Firm’s businesses, and from
conducting business and being taxed in a
substantial number of jurisdictions, significant
judgments and estimates are required to be
made. Agreement of tax liabilities between JPMorgan
Chase and the many tax jurisdictions in which the
Firm files tax returns may not be finalized for
several years. Thus, the Firm’s final tax-related
assets and liabilities may ultimately be different
than those currently reported.
The components of income tax expense (benefit)
included in the Consolidated Statements of
Income were as follows.
Year ended December 31, (in millions)
2008
2007
2006
Current income tax expense
U.S. federal
$
395
$
2,805
$
5,512
Non-U.S.
1,009
2,985
1,656
U.S. state and local
307
343
879
Total current income tax expense
1,711
6,133
8,047
Deferred income tax expense (benefit)
U.S. federal
(3,015
)
1,122
(1,628
)
Non-U.S.
1
(185
)
194
U.S. state and local
377
370
(376
)
Total deferred income tax
expense (benefit)
(2,637
)
1,307
(1,810
)
Total income tax expense (benefit)
from continuing operations
(926
)
7,440
6,237
Total income tax expense
from discontinued operations
—
—
572
Total income tax expense (benefit)
$
(926
)
$
7,440
$
6,809
Total income tax expense includes $55 million,
$74 million, and $367 million of tax benefits
recorded in 2008, 2007 and 2006, respectively, as a
result of tax audit resolutions.
The preceding table does not reflect the tax
effect of certain items that are recorded each
period directly in stockholders’ equity and certain
tax benefits associated with the Firm’s employee
stock-based compensation plans. The table does not
reflect the cumulative tax effects of initially
implementing new accounting pronouncements in 2007
and 2006. The tax effect of all items recorded
directly to stockholders’ equity was an increase in
stockholders’ equity of $3.0 billion, $159 million
and $885 million in 2008, 2007 and 2006,
respectively.
U.S. federal income taxes have not been provided on
the undistributed earnings of certain non-U.S.
subsidiaries, to the extent that such earnings have
been reinvested abroad for an indefinite period of
time. During 2008, as part of JPMorgan Chase’s
periodic review of the business requirements and
capital needs of its non-U.S. subsidiaries,
combined with the formation of specific strategies
and steps taken to fulfill these requirements and
needs, the Firm determined that the undistributed
earnings of certain of its subsidiaries, for which
U.S. federal income taxes had been provided, will
remain indefinitely reinvested to fund the current
and future growth of the related businesses. As
management does not intend to use the earnings of
these subsidiaries as a source of funding for its
U.S. operations, such earnings will not be
distributed to the U.S. in the foreseeable future.
This determination resulted in the release of
deferred tax liabilities and the recognition of an
income tax benefit of $1.1 billion associated with
these undistributed earnings. For 2008, pretax
earnings of approximately $2.5 billion were
generated that will remain indefinitely invested in
these subsidiaries. At December 31, 2008, the
cumulative amount of undistributed pretax earnings
in these subsidiaries approximated $12.9 billion.
If the Firm were to record a deferred tax liability
associated with these undistributed earnings, the
amount would be $2.9 billion at December 31, 2008.
The tax expense (benefit) applicable to securities
gains and losses for the years 2008, 2007 and 2006
was $608 million, $60 million and $(219) million,
respectively.
A reconciliation of the applicable statutory U.S.
income tax rate to the effective tax rate for
continuing operations for the past three years is
shown in the following table.
U.S. state and local income taxes, net
of federal income tax benefit
16.0
2.0
2.1
Tax-exempt income
(14.8
)
(2.4
)
(2.2
)
Non-U.S. subsidiary earnings
(53.6
)
(1.1
)
(0.5
)
Business tax credits
(24.5
)
(2.5
)
(2.5
)
Bear Stearns equity losses
5.7
—
—
Other, net
2.8
1.6
(0.5
)
Effective tax rate
(33.4
)%
32.6
%
31.4
%
Deferred income tax expense (benefit) results
from differences between assets and liabilities
measured for financial reporting and for income-tax
return purposes. The significant components of
deferred tax assets and liabilities are reflected
in the following table.
December 31, (in millions)
2008
2007
Deferred tax assets
Allowance for loan losses
$
8,029
$
3,800
Employee benefits
4,841
3,391
Allowance for other than loan losses
3,686
3,635
Fair value adjustments
2,565
—
Non-U.S. operations
2,504
285
Tax attribute carryforwards
1,383
—
Gross deferred tax assets
$
23,008
$
11,111
Deferred tax liabilities
Depreciation and amortization
$
4,681
$
2,966
Leasing transactions
1,895
2,304
Fee income
1,015
548
Non-U.S. operations
946
1,790
Fair value adjustments
—
570
Other, net
202
207
Gross deferred tax liabilities
$
8,739
$
8,385
Valuation allowance
1,266
220
Net deferred tax asset
$
13,003
$
2,506
JPMorgan Chase has recorded deferred tax assets
of $1.4 billion in connection with net operating
loss and business tax credit carry forwards. The
U.S. federal net operating loss carryforward of
approximately $1.3 billion, the state and local net
operating loss carryforwards of approximately $7.2
billion, and the business tax credit carryforward
of approximately $300 million are subject to annual
limitations on utilization. If not utilized, the
net operating losses would expire in 2026, 2027 and
2028, and the business tax credits would expire in
2028. In addition, an alternative minimum tax
credit carry-forward has been recorded for
approximately $200 million and has an indefinite
carryforward period.
A valuation allowance has been recorded relating to
state and local net operating losses, losses
associated with non-U.S. subsidiaries and losses
associated with certain portfolio investments. The
increase in the valuation allowance from the prior
year to 2008 is largely related to Bear Stearns.
The Firm adopted and applied FIN 48, which
addresses the recognition and measurement of tax
positions taken or expected to be taken, and also
provides guidance on derecognition, classification,
interest and penalties, accounting in interim
periods and disclosure, to all of its
income tax positions at the required effective date
of January 1, 2007, resulting in a $436 million
cumulative effect increase to retained earnings, a
reduction in goodwill of $113 million and a $549
million decrease in the liability for income taxes.
At December 31, 2008 and 2007, JPMorgan Chase’s
unrecognized tax benefits, excluding related
interest expense and penalties, were
$5.9 billion and $4.8 billion, respectively, of which $2.9 billion and
$1.3 billion, if recognized, would reduce the
annual effective tax rate. As JPMorgan Chase is
presently under audit by a number of tax
authorities, it is reasonably possible that
unrecognized tax benefits could significantly
change over the next 12 months, which could also
significantly impact JPMorgan Chase’s quarterly and
annual effective tax rates.
The following table presents a reconciliation of
the beginning and ending amount of unrecognized tax
benefits for the years 2008 and 2007.
Unrecognized tax benefits
Year ended December 31, (in millions)
2008
2007
Balance at January 1,
$
4,811
$
4,677
Increases based on tax positions related to
the current period
890
434
Decreases based on tax positions related to the
current period
(109
)
(241
)
Increases
associated with the Bear Stearns merger
1,387
—
Increases based on tax positions related to
prior periods
501
903
Decreases based on tax positions related to
prior periods
(1,386
)
(791
)
Decreases related to settlements with taxing
authorities
(181
)
(158
)
Decreases related to a lapse of applicable
statute of limitations
(19
)
(13
)
Balance at December 31,
$
5,894
$
4,811
Pretax interest expense and penalties related
to income tax liabilities recognized in income tax
expense were $571 million ($346 million after-tax)
in 2008 and $516 million ($314 million after-tax)
in 2007. Included in accounts payable and other
liabilities at December 31, 2008 and 2007, in
addition to the Firm’s liability for unrecognized
tax benefits, was $2.3 billion and $1.6 billion,
respectively, for income tax-related interest and
penalties, of which the penalty component was
insignificant.
JPMorgan Chase is subject to ongoing tax
examinations by the tax authorities of the various
jurisdictions in which it operates, including U.S.
federal and state and non-U.S.
jurisdictions. The Firm’s consolidated federal
income tax returns are presently under examination
by the Internal Revenue Service (“IRS”) for the
years 2003, 2004 and 2005. The consolidated federal
income tax returns of Bank One Corporation, which
merged with and into JPMorgan Chase on July 1,2004, are under examination for the years 2000
through 2003, and for the period January 1, 2004,
through July 1, 2004. The consolidated federal
income tax returns of Bear Stearns for the years
ended November 30, 2003, 2004 and 2005, are also under
examination. All three examinations are expected to
conclude in 2009. The IRS audits of the
consolidated federal income tax returns of JPMorgan
Chase for the years 2006 and 2007, and for Bear
Stearns for the years ended November 30, 2006 and 2007, are expected
to commence in 2009. Administrative appeals are
pending with the IRS relating to prior examination
periods. For 2002 and prior years, refund claims
relating to income and credit adjustments, and to
tax attribute carrybacks, for JPMorgan Chase and
its predecessor entities, including Bank One, have
been filed. Amended returns to reflect refund
claims primarily attributable to net operating
losses and tax credit carrybacks will be filed for
the final Bear Stearns federal consolidated tax
return for the period December 1, 2007, through May 30, 2008, and for prior years.
The following table presents the U.S. and non-U.S.
components of income from continuing operations
before income tax expense (benefit).
Year ended December 31, (in millions)
2008
2007
2006
U.S.
$
(2,094
)
$
13,720
$
12,934
Non-U.S.(a)
4,867
9,085
6,952
Income from continuing operations
before income tax
expense (benefit)
$
2,773
$
22,805
$
19,886
(a)
For purposes of this table, non-U.S. income is defined as income generated from
operations located outside the U.S.
Note
29 – Restrictions on cash and
intercompany funds transfers
The business of JPMorgan Chase Bank, National Association
(“JPMorgan Chase Bank, N.A.”) is subject to
examination and regulation by the Office of the
Comptroller of the Currency (“OCC”). The Bank is a
member of the U.S. Federal Reserve System, and its
deposits are insured by the FDIC as discussed in Note 20 on
page 190 of this Annual Report.
The Board of Governors of the Federal Reserve
System (the “Federal Reserve”) requires depository
institutions to maintain cash reserves with a
Federal Reserve Bank. The average amount of
reserve balances deposited by the Firm’s bank
subsidiaries with various Federal Reserve Banks
was approximately $1.6 billion in 2008 and 2007.
Restrictions imposed by U.S. federal law prohibit
JPMorgan Chase and certain of its affiliates from
borrowing from banking subsidiaries unless the
loans are secured in specified amounts. Such
secured loans
to the Firm or to other affiliates are generally
limited to 10% of the banking subsidiary’s total
capital, as determined by the risk-based capital
guidelines; the aggregate amount of all such loans
is limited to 20% of the banking subsidiary’s total
capital.
The principal sources of JPMorgan Chase’s income
(on a parent company–only basis) are dividends and
interest from JPMorgan Chase Bank, N.A., and the
other banking and nonbanking subsidiaries of
JPMorgan Chase. In addition to dividend
restrictions set forth in statutes and regulations,
the Federal Reserve, the OCC and the FDIC have
authority under the Financial Institutions
Supervisory Act to prohibit or to limit the payment
of dividends by the banking organizations they
supervise, including JPMorgan Chase and its
subsidiaries that are banks or bank holding
companies, if, in the banking regulator’s opinion,
payment of a dividend would constitute an unsafe or
unsound practice in light of the financial
condition of the banking organization.
At January 1, 2009 and 2008, JPMorgan Chase’s
banking subsidiaries could pay, in the aggregate,
$17.0 billion and $16.2 billion, respectively, in
dividends to their respective bank holding
companies without the prior approval of their
relevant banking regulators. The capacity to pay
dividends in 2009 will be supplemented by the
banking subsidiaries’ earnings during the year.
In compliance with rules and regulations
established by U.S. and non-U.S. regulators, as of
December 31, 2008 and 2007, cash in the amount of
$20.8 billion and $16.0 billion, respectively, and
securities with a fair value of $12.1 billion and
$3.4 billion, respectively, were segregated in
special bank accounts for the benefit of securities
and futures brokerage customers.
The Federal Reserve establishes capital
requirements, including well-capitalized standards
for the consolidated financial holding company. The
OCC establishes similar capital requirements and
standards for the Firm’s national banks, including
JPMorgan Chase Bank, N.A., and Chase Bank USA, N.A.
There are two categories of risk-based capital:
Tier 1 capital and Tier 2 capital. Tier 1 capital
includes common stockholders’ equity, qualifying
preferred stock and minority interest less goodwill
and other adjustments. Tier 2 capital consists of
preferred stock not qualifying as Tier 1,
subordinated long-term debt and other instruments
qualifying as Tier 2, and the aggregate allowance
for credit losses up to a certain percentage of
risk-weighted assets. Total regulatory capital is
subject to deductions for investments in certain
subsidiaries. Under the risk-based capital
guidelines of the Federal Reserve, JPMorgan Chase
is required to maintain minimum ratios of Tier 1
and Total (Tier 1 plus Tier 2)
capital to risk-weighted assets, as well as minimum
leverage ratios (which are defined as Tier 1
capital to average adjusted on-balance sheet
assets). Failure to meet these minimum requirements
could cause the Federal Reserve to take action.
Banking subsidiaries also are subject to these
capital
requirements by their respective primary
regulators. As of December 31, 2008 and 2007,
JPMorgan Chase and all of its banking subsidiaries
were well-capitalized and met all capital
requirements to which each was subject.
The Federal Reserve granted the Firm, for a period
of 18 months following the Bear Stearns merger,
relief up to a certain specified amount and
subject to certain conditions from the Federal
Reserve’s risk-based capital and leverage
requirements with respect to Bear Stearns’
risk-weighted assets and other exposures acquired.
The amount of such relief is subject to reduction
by one-sixth each quarter subsequent to the merger
and expires on October 1, 2009. The OCC granted
JPMorgan Chase Bank, N.A. similar relief from its
risk-based capital and leverage requirements.
The following table presents the risk-based capital ratios for JPMorgan Chase and its significant
banking subsidiaries at December 31, 2008 and 2007.
Asset and capital amounts for JPMorgan Chase’s banking subsidiaries reflect intercompany
transactions, whereas the respective amounts for JPMorgan Chase reflect the elimination of
intercompany transactions.
(b)
As defined by the regulations issued by the Federal Reserve, OCC and FDIC.
(c)
Includes off-balance sheet risk-weighted assets in the amounts of $357.5 billion, $332.2
billion and $18.6 billion, respectively, at December 31, 2008, and $352.7 billion, $336.8 billion
and $13.4 billion, respectively, at December 31, 2007, for JPMorgan Chase, JPMorgan Bank, N.A. and
Chase Bank USA, N.A.
(d)
Adjusted average assets, for purposes of calculating the leverage ratio, include total average
assets adjusted for unrealized gains/losses on securities, less deductions for disallowed goodwill
and other intangible assets, investments in certain subsidiaries and the total adjusted carrying
value of nonfinancial equity investments that are subject to deductions from Tier 1 capital.
(e)
Represents requirements for banking subsidiaries pursuant to regulations issued under the
Federal Deposit Insurance Corporation Improvement Act. There is no Tier 1 leverage component in the
definition of a well-capitalized bank holding company.
(f)
The minimum Tier 1 leverage ratio for bank holding companies and banks is 3% or 4% depending on
factors specified in regulations issued by the Federal Reserve and OCC.
Note:
Rating agencies allow
measures of capital to be adjusted upward for deferred tax liabilities which have resulted from
both nontaxable business combinations and from tax-deductible goodwill. The Firm had deferred tax
liabilities resulting from nontaxable business combinations totaling $1.1 billion at December 31,2008, and $2.0 billion at December 31, 2007. Additionally, the Firm had deferred tax liabilities
resulting from tax-deductible goodwill of $1.6 billion at December 31, 2008, and $939 million at
December 31, 2007.
Long-term debt and other instruments
qualifying as Tier 2
31,659
32,817
Qualifying allowance for credit losses
17,187
10,084
Adjustment for investments in certain
subsidiaries and other
(230
)
595
Tier 2 capital
48,616
43,496
Total qualifying capital
$
184,720
$
132,242
(a)
Primarily includes trust preferred capital debt securities of certain business trusts.
Note 31
– Commitments and contingencies
At December 31, 2008, JPMorgan Chase and its
subsidiaries were obligated under a number of
noncancelable operating leases for premises and
equipment used primarily for banking purposes, and
for energy-related tolling service agreements.
Certain leases contain renewal options or
escalation clauses providing for increased rental
payments based upon maintenance, utility and tax
increases or require the Firm to perform
restoration work on leased premises. No lease
agreement imposes restrictions on the Firm’s
ability to pay dividends, engage in debt or equity
financing transactions or enter into further lease
agreements.
The following table presents required future
minimum rental payments under operating leases
with noncancelable lease terms that expire after
December 31, 2008.
Year ended December 31, (in millions)
2009
$
1,676
2010
1,672
2011
1,543
2012
1,456
2013
1,387
After 2013
9,134
Total minimum payments required(a)
16,868
Less: Sublease rentals under noncancelable subleases
(2,266
)
Net minimum payment required
$
14,602
(a)
Lease restoration obligations are accrued in accordance with SFAS 13, and are not
reported as a required minimum lease payment.
Total rental expense was as follows.
Year ended December 31, (in millions)
2008
2007
2006
Gross rental expense
$
1,917
$
1,380
$
1,266
Sublease rental income
(415
)
(175
)
(194
)
Net rental expense
$
1,502
$
1,205
$
1,072
At December 31, 2008, assets were pledged to
secure public deposits and for other purposes.
The significant components of the assets pledged
were as follows.
December 31, (in billions)
2008
2007
Reverse repurchase/securities borrowing
agreements
$
456.6
$
333.7
Securities
31.0
4.5
Loans
342.3
160.4
Trading assets and other
98.0
102.2
Total
assets
pledged(a)
$
927.9
$
600.8
(a)
Total assets pledged do not include assets of consolidated
VIEs. These assets are generally used to satisfy liabilities to third
parties. See Note 17 on pages 177–186 of this Annual Report
for additional information on assets and liabilities of consolidated
VIEs.
The Firm has resolved with the IRS issues
related to compliance with reporting and
withholding requirements for certain accounts
transferred to The Bank of New York Mellon Corporation
(“BNYM”) in connection with the Firm’s sale to BNYM
of its corporate trust business. The resolution of
these issues did not have a material effect on the
Firm.
Note 32 – Accounting for derivative
instruments and hedging activities
Derivative instruments enable end-users to
increase, reduce or alter exposure to credit or
market risks. The value of a derivative is derived
from its reference to an underlying variable or
combination of variables such as equity, foreign
exchange, credit, commodity or interest rate prices
or indices. JPMorgan Chase makes markets in
derivatives for customers and also is an end-user
of derivatives in order to hedge or manage risks of
market exposures, modify the interest rate
characteristics of related balance sheet
instruments or meet longer-term investment
objectives. The majority of the Firm’s derivatives
are entered into for market-making purposes. SFAS
133, as amended by SFAS 138, SFAS 149, SFAS 155 and
FSP FAS 133-1, establishes accounting and reporting
standards for derivative instruments, including
those used for trading and hedging activities and
derivative instruments embedded in other contracts.
All free-standing derivatives are required to be
recorded on the Consolidated Balance Sheets at fair
value. The accounting for changes in value of a
derivative depends on whether or not the contract
has been designated and qualifies for hedge
accounting. Derivative receivables and payables,
whether designated for hedging relationships or
not, are recorded in trading assets and trading
liabilities as set forth in Note 6 on page 147 of
this Annual Report.
Derivatives used for trading purposes
The Firm makes markets in derivatives for customers
seeking to modify, or reduce interest rate, credit,
foreign exchange, equity and commodity and other
market risks or for risk-taking purposes. The Firm
typically manages its exposure from such
derivatives by entering into derivatives or other
financial instruments that partially or fully
offset the exposure from the client transaction.
The Firm actively manages any residual exposure and
seeks to earn a spread between the client
derivatives and offsetting positions. For the
Firm’s own account, the Firm uses derivatives to
take risk positions or to benefit from differences
in prices between derivative markets and markets
for other financial instruments.
Derivatives used for risk management purposes
Interest rate contracts, which are generally
interest rate swaps, forwards and futures are
utilized in the Firm’s risk management activities
to minimize fluctuations in earnings caused by
interest rate volatility. As a result of interest
rate fluctuations, fixed-rate assets and
liabilities appreciate or depreciate in market
value. Gains or losses on the derivative
instruments that are linked to fixed-rate assets
and liabilities and forecasted transactions are
expected to offset substantially this unrealized
appreciation or depreciation. Interest income and
interest expense on variable-rate assets and
liabilities and on forecasted transactions increase
or
decrease as a result of interest rate fluctuations.
Gains and losses on the derivative instruments that
are linked to assets and liabilities and forecasted
transactions are expected to offset substantially
this variability in earnings. Interest rate swaps
involve the exchange of fixed-rate and
variable-rate interest payments based on the
contracted notional amount. Forward contracts used
for the Firm’s interest rate risk management
activities are primarily arrangements to exchange
cash in the future
based on price movements of specified financial
instruments. Futures contracts used are primarily
index futures which provide for cash payments based
upon the movements of an underlying rate index.
The Firm uses foreign currency contracts to manage
the foreign exchange risk associated with certain
foreign currency-denominated
(i.e., non-U.S.) assets and liabilities and
forecasted transactions denominated in a foreign
currency, as well as the Firm’s equity investments
in foreign subsidiaries. As a result of foreign
currency fluctuations, the U.S. dollar equivalent
values of the foreign currency-denominated assets
and liabilities or forecasted transactions change.
Gains or losses on the derivative instruments that
are linked to the foreign currency denominated
assets or liabilities or forecasted transactions
are expected to offset substantially this
variability. Foreign exchange forward contracts
represent agreements to exchange the currency of
one country for the currency of another country at
an agreed-upon price on an agreed-upon settlement
date.
The Firm uses forward contracts to manage the
overall price risk associated with the gold
inventory in its commodities portfolio. As a result
of gold price fluctuations, the fair value of the
gold inventory changes. Gains or losses on the
derivative instruments that are linked to gold
inventory are expected to substantially offset this
unrealized appreciation or depreciation. Forward
contracts used for the Firm’s gold inventory risk
management activities are arrangements to deliver
gold in the future.
The Firm uses credit derivatives to manage the
credit risk associated with loans, lending-related
commitments and derivative receivables, as well as
exposure to residential and commercial mortgages.
Credit derivatives compensate the purchaser when
the entity referenced in the contract experiences
a credit event such as bankruptcy or a failure to
pay an obligation when due. For a further
discussion of credit derivatives, see the
discussion below.
In order to qualify for hedge accounting, a
derivative must be considered highly effective at
reducing the risk associated with the exposure
being hedged. In order for a derivative to be
designated as a hedge, there must be documentation
of the risk management objective and strategy,
including identification of the hedging instrument,
the hedged item and the risk exposure, and how
effectiveness is to be assessed prospectively and
retrospectively. To assess effectiveness, the Firm
uses statistical methods such as regression
analysis, as well
as nonstatistical methods including dollar value
comparisons of the change in the fair value of the
derivative to the change in the fair value or cash
flows of the hedged item. The extent to which a
hedging instrument has been and is expected to
continue to be effective at achieving offsetting
changes in fair value or cash flows must be
assessed and documented at least quarterly. Any
ineffectiveness must be reported in current-period
earnings. If it is determined that a derivative is
not highly effective at hedging the designated
exposure, hedge accounting is discontinued.
For qualifying fair value hedges, all changes in
the fair value of the derivative and in the fair
value of the hedged item for the risk being hedged
are recognized in earnings. If the hedge
relationship is terminated, then the fair value
adjustment to the hedged item continues
to be reported as part of the basis of the item and
continues to be amortized to earnings as a yield
adjustment. For qualifying cash flow hedges, the
effective portion of the change in the fair value
of the derivative is recorded in other
comprehensive income (loss) and recognized in the
Consolidated Statements of Income when the hedged
cash flows affect earnings. The ineffective
portions of cash flow hedges are immediately
recognized in earnings. If the hedge relationship
is terminated, then the change in fair value of the
derivative recorded in accumulated other comprehensive income (loss)
is recognized when the cash flows that were hedged
occur, consistent with the original hedge strategy.
For hedge relationships that are discontinued
because the forecasted transaction is not expected
to occur according to the original strategy, any
related derivative amounts recorded in accumulated other
comprehensive income (loss) are immediately recognized in
earnings. For qualifying net investment hedges,
changes in the fair value of the derivative or the
revaluation of the foreign currency–denominated
debt instrument are recorded in the translation
adjustments account within accumulated other
comprehensive income (loss).
JPMorgan Chase’s fair value hedges primarily
include hedges of the interest rate risk inherent
in fixed-rate long-term debt, warehouse loans, AFS
securities, and the overall price of gold
inventory. All changes in the hedging derivative’s
fair value are included in earnings consistent with
the classification of the hedged item, primarily
net interest income for long-term debt and AFS
securities; other income for warehouse loans; and
principal transactions revenue for gold inventory.
The Firm did not recognize any gains or losses
during 2008, 2007 or 2006 on firm commitments that
no longer qualified as fair value hedges.
JPMorgan Chase also enters into derivative
contracts to hedge exposure to variability in cash
flows from floating-rate financial instruments and
forecasted transactions, primarily the rollover of
short-term assets and liabilities, and foreign
currency–denominated revenue and expense. All
hedging derivative amounts affecting earnings are
recognized consistent with the classification of
the hedged item, primarily net interest
income.
The Firm uses forward foreign exchange contracts
and foreign currency–denominated debt instruments
to protect the value of net investments in
subsidiaries whose functional currency is not the
U.S. dollar. The portion of the hedging derivative
excluded from the assessment of hedge effectiveness
(i.e., forward points) is recorded in net interest
income.
JPMorgan Chase does not seek to apply hedge
accounting to all of the Firm’s economic hedges.
For example, the Firm does not apply hedge
accounting to purchased credit default swaps used
to manage the credit risk of loans and commitments
because of the difficulties in qualifying such
contracts as hedges under SFAS 133. Similarly, the
Firm does not apply hedge accounting to certain
interest rate derivatives used as economic hedges.
The following table presents derivative
instrument hedging-related activities for the
periods indicated.
Year ended December 31, (in millions)
2008
2007
2006
Fair value hedge ineffective net
gains(a)
$
434
$
111
$
51
Cash flow hedge ineffective net
gains(a)
18
29
2
Cash flow hedging net gains on
forecasted transactions that failed to occur
—
15
(b)
—
(a)
Includes ineffectiveness and the components of hedging instruments that have been
excluded from the assessment of hedge effectiveness.
(b)
During the second half of 2007, the Firm did not issue short-term fixed rate
Canadian dollar denominated notes due to the weak credit market for Canadian short-term
debt.
Over the next 12 months, it is expected that
$348 million (after-tax) of net losses recorded in
accumulated other comprehensive income (loss) at
December 31, 2008, will be recognized in earnings.
The maximum length of time over which forecasted
transactions are hedged is ten years, and such
transactions primarily relate to core lending and
borrowing activities.
Credit derivatives
Credit derivatives are financial instruments whose
value is derived from the credit risk associated
with the debt of a third party issuer (the
reference entity) and which allow one party (the
protection purchaser) to transfer that risk to
another party (the protection seller). Credit
derivatives expose the protection purchaser to the
creditworthiness of the protection seller, as the
protection seller is required to make payments
under the contract when the reference entity experiences a credit event, such
as a bankruptcy, failure to pay its obligation, or
a restructuring. The seller of credit protection
receives a premium for providing protection, but
has the risk that the underlying instrument
referenced in the contract will be subjected to a
credit event.
The Firm is both a purchaser and seller of credit
protection in the credit derivatives market and
uses credit derivatives for two primary purposes.
First, in its capacity
as a market-maker in the dealer/client business,
the Firm actively risk manages a portfolio of credit
derivatives by purchasing and selling credit
protection, predominantly on corporate debt
obligations, to meet the needs of customers. As a
seller of protection, the Firm’s exposure to a
given reference entity may be offset partially, or
entirely, with a contract to purchase protection
from another counterparty on the same or similar
reference entity. Second, the Firm uses credit
derivatives in order to mitigate the Firm’s credit
risk associated with the overall derivative
receivables and traditional commercial credit
lending exposures (loans and unfunded commitments)
as well as to manage its exposure to residential
and commercial mortgages. See Note 4 on pages
129–143 of this Annual Report for further
information on the Firm’s mortgage-related
exposures. In accomplishing the above, the Firm
uses different types of credit derivatives.
Following is a summary of various types of credit
derivatives.
Credit default swaps
Credit derivatives may reference the credit of
either a single reference entity (“single-name”) or
a broad-based index, as described further below. The Firm purchases and sells protection
on both single-name and index-reference
obligations. Single-name credit default swaps
(“CDS”) and index CDS contracts are both OTC
derivative contracts. Single-name CDS are used to
manage the default risk of a single reference
entity, while CDS index are used to manage credit
risk associated with the broader credit markets or
credit market segments. Like the S&P 500 and other
market indices, a CDS index is comprised of a
portfolio of CDS across many reference entities.
New series of CDS indices are established
approximately every six months with a new
underlying portfolio of reference entities to
reflect changes in the credit markets. If one of
the reference entities in the index experiences a
credit event, then the reference entity that
defaulted is removed from the index and is replaced
with another reference entity. CDS can also be
referenced against specific portfolios of reference
names or against customized exposure levels based
on specific client demands: for example, to provide
protection against the first $1 million of realized
credit losses in a $10 million portfolio of
exposure. Such structures are commonly known as
tranche CDS.
For both single-name CDS contracts and index CDS,
upon the occurrence of a credit event, under the
terms of a CDS contract neither party to the CDS
contract has recourse to the reference entity. The
protection purchaser has recourse to the protection
seller for the difference between the face value of
the CDS contract and the fair value of the
reference obligation at the time of settling the
credit derivative contract, also known as the
recovery value. The protection purchaser does not
need to hold the debt instrument of the underlying
reference entity in order to receive amounts due
under the CDS contract when a credit event occurs.
Credit-linked notes
A credit linked note (“CLN”) is a funded credit
derivative where the issuer of the CLN purchases
credit protection on a referenced entity from the
note investor. Under the contract, the investor
pays the issuer par value of the note at the
inception of the transaction, and in return, the
issuer pays periodic payments to the investor,
based on the credit risk of the referenced entity.
The issuer also repays the investor the par value
of the note at maturity unless the reference entity
experiences a specified credit event. In that
event, the issuer is not obligated to repay the par
value of the note, but rather, the issuer pays the
investor the
difference between the par value of the note and
the fair value of the defaulted reference
obligation at the time of settlement. Neither party
to the CLN has recourse to the defaulting reference
entity. For a further discussion of CLNs, see Note
17 on pages 182–183 of this Annual Report.
The following table presents a summary of the
notional amounts of credit derivatives and
credit-linked notes the Firm sold and purchased,
and the net position as of December 31, 2008. Upon
a credit event, the Firm as seller of protection
would typically pay out only a percentage of the
full notional of net protection sold; as the amount
that is actually required to be paid on the
contracts take into account the recovery value of
the reference obligation at the time of settlement.
The Firm manages the credit risk on contracts to sell protection by
purchasing protection with identical or similar underlying reference
entities; as such other protection purchased
referenced in the following table includes credit derivatives bought on related, but
not identical reference positions, including
indices, portfolio coverage and other reference
points, which further mitigates the risk associated with the net protection
sold.
Primarily consists of total return swaps and options to enter
into credit default swap contracts.
(b)
Represents the notional amount of purchased credit derivatives where the
underlying reference instrument is identical to the reference instrument on which the Firm
has sold credit protection.
(c)
Does not take into account the fair value of the reference obligation at the time
of settlement, which would generally reduce the amount the seller of protection pays to
the buyer of protection in determining settlement value.
(d)
Represents single-name and index CDS protection the Firm purchased primarily to
risk manage the net protection sold.
The following table summarizes the notional and fair value amounts of credit derivatives and
credit-linked notes as of December 31, 2008, where JPMorgan Chase is the seller of protection. The
maturity profile presents the years to maturity based upon the remaining contractual maturity of
the credit derivative contracts. The ratings profile is based on the rating of the reference entity
on which the credit derivative contract is based. The ratings and
maturity profile of protection purchased is comparable to the profile
reflected below.
Protection sold – credit derivatives and credit-linked notes ratings/maturity profile(a)
The contractual maturity for single-name CDS contract generally ranges from three
months to ten years and the contractual maturity for index CDS is generally five years.
The contractual maturity for CLNs typically ranges from three to five years.
(b)
Ratings scale is based upon the Firm’s internal ratings, which generally
correspond to ratings defined by S&P and Moody’s.
(c)
Amounts are shown on a gross basis, before the benefit of legally enforceable
master netting agreements and cash collateral held by the Firm.
Note 33 – Off-balance sheet lending-related
financial instruments and guarantees
JPMorgan Chase utilizes lending-related
financial instruments (e.g., commitments and
guarantees) to meet the financing needs of its
customers. The contractual amount of these
financial instruments represents the maximum
possible credit risk should the counterparties draw
down on these commitments or the Firm fulfills its
obligation under these guarantees, and the
counterparties subsequently fail to perform
according to the terms of these contracts. Most of
these commitments and guarantees expire without a
default occurring or without being drawn. As a
result, the total contractual amount of these
instruments is not, in the Firm’s view,
representative of its actual future credit exposure
or funding requirements. Further, certain
commitments, predominantly related to consumer
financings, are cancelable, upon notice, at the
option of the Firm.
To provide for the risk of loss inherent in
wholesale related contracts, an allowance for
credit losses on lending-related commitments is
maintained. See Note 15 on pages 166–168 of this
Annual Report for further discussion of the
allowance for credit losses on lending-related
commitments.
The following table summarizes the contractual
amounts of off-balance sheet lending-related
financial instruments and guarantees and the
related allowance
for credit losses on lending-related commitments at
December 31, 2008 and 2007.
Off-balance sheet lending-related financial instruments and guarantees
Allowance for
Contractual amount
lending-related commitments
December 31, (in millions)
2008
2007
2008
2007
Lending-related
Consumer(a)
$
741,507
$
815,936
$
25
$
15
Wholesale:
Other unfunded commitments to extend credit(b)(c)(d)(e)
225,863
250,954
349
571
Asset purchase agreements(f)
53,729
90,105
9
9
Standby letters of credit and financial guarantees(c)(g)(h)
95,352
100,222
274
254
Other letters of credit(c)
4,927
5,371
2
1
Total wholesale
379,871
446,652
634
835
Total lending-related
$
1,121,378
$
1,262,588
$
659
$
850
Other guarantees
Securities lending guarantees(i)
$
169,281
$
385,758
NA
NA
Residual value guarantees
670
NA
NA
NA
Derivatives qualifying as guarantees(j)
83,835
85,262
NA
NA
(a)
Includes credit card and home equity lending-related commitments of $623.7 billion
and $95.7 billion, respectively, at December 31, 2008; and $714.8 billion and $74.2
billion, respectively, at December 31, 2007. These amounts for credit card and home equity
lending-related commitments represent the total available credit for these products. The
Firm has not experienced, and does not anticipate, that all available lines of credit for
these products will be utilized at the same time. The Firm can reduce or cancel these
lines of credit by providing the borrower prior notice or, in some cases, without notice
as permitted by law.
(b)
Includes unused advised lines of credit totaling $36.3 billion and $38.4 billion
at December 31, 2008 and 2007, respectively, which are not legally binding. In regulatory
filings with the Federal Reserve, unused advised lines are not reportable.
(c)
Represents contractual amount net of risk participations totaling $28.3 billion at
both December 31, 2008 and 2007.
(d)
Excludes unfunded commitments to third-party private equity funds of $1.4 billion
and $881 million at December 31, 2008 and 2007, respectively. Also excludes unfunded
commitments for other equity investments of $1.0 billion and $903 million at December 31,2008 and 2007, respectively.
(e)
Includes commitments to investment and noninvestment grade counterparties in
connection with leveraged acquisitions of $3.6 billion and $8.2 billion at December 31,2008 and 2007, respectively.
(f)
Largely represents asset purchase agreements with the Firm’s administered
multi-seller, asset-backed commercial paper conduits. It also includes $96 million and
$1.1 billion of asset purchase agreements to other third-party entities at December 31,2008 and 2007, respectively.
(g)
JPMorgan Chase held collateral relating to $31.0 billion and $31.5 billion of
these arrangements at December 31, 2008 and 2007, respectively. Prior periods have been
revised to conform to the current presentation.
(h)
Includes unissued standby letters of credit commitments of $39.5 billion and $50.7
billion at December 31, 2008 and 2007, respectively.
(i)
Collateral held by the Firm in support of securities lending indemnification
agreements was $170.1 billion and $390.5 billion at December 31, 2008 and 2007,
respectively. Securities lending collateral comprises primarily cash, securities issued by
governments that are members of the Organisation for Economic Co-operation and Development
and U.S. government agencies.
(j)
Represents notional amounts of derivatives qualifying as guarantees.
Other unfunded commitments to extend credit
Unfunded commitments to extend credit are
agreements to lend or to purchase securities only
when a customer has complied with predetermined
conditions, and they generally expire on fixed
dates.
Other unfunded commitments to extend credit include
commitments to U.S. domestic states and
municipalities, hospitals and other not-for-profit
entities to provide funding for periodic tenders of
their variable-rate demand bond obligations or
commercial paper. Performance by the Firm is
required in the event that the variable-rate demand
bonds or commercial paper cannot be remarketed to
new investors. The performance required of the Firm
under these agreements is conditional and limited
by certain termination events, which include
bankruptcy and the credit rating downgrade of the
issuer of the variable-rate demand bonds or
commercial paper to below certain predetermined
thresholds. The commitment period is generally one
to three years. The amount of commitments related
to variable-rate demand bonds and commercial paper
of U.S. domestic states and municipalities,
hospitals and not-for-profit entities at December31, 2008 and 2007, was $23.5 billion and $24.1 billion, respectively.
Included in other unfunded commitments to extend
credit are commitments to investment and
noninvestment grade counterparties in connection
with leveraged acquisitions. These commitments are
dependent on whether the acquisition by the
borrower is successful, tend to be short-term in
nature and, in most cases, are subject to certain
conditions based on the borrower’s financial
condition or other factors. Additionally, the Firm
often syndicates portions of the commitment to
other investors, depending on market conditions.
These commitments often contain flexible pricing
features to adjust for changing market conditions
prior to closing. Alternatively, the borrower may
turn to the capital markets for required funding
instead of drawing on the commitment provided by
the Firm, and the commitment may expire unused. As
such, these commitments may not necessarily be
indicative of the Firm’s actual risk, and the total
commitment amount may not reflect actual future
cash flow requirements. The amount of commitments
related to leveraged acquisitions at December 31,2008 and 2007, was $3.6 billion and $8.2 billion,
respectively. For further information, see Note 4
and Note 5 on pages 129–143 and 144–146,
respectively, of this Annual Report.
FIN 45 guarantees
FIN 45 establishes accounting and disclosure
requirements for guarantees, requiring that a
guarantor recognize, at the inception of a
guarantee, a liability in an amount equal to the
fair value of the obligation undertaken in issuing
the guarantee. FIN 45 defines a guarantee as a
contract that contingently requires the guarantor
to pay a guaranteed party, based upon: (a) changes
in an underlying asset, liability or equity
security of the guaranteed party; or (b) a third
party’s failure to perform under a specified
agreement. The Firm considers the following
off-balance sheet lending-related arrangements to
be guarantees under FIN 45: certain
asset purchase agreements, standby letters of
credit and financial guarantees, securities lending
indemnifications, certain indemnification
agreements included within third-party contractual
arrangements and certain derivative contracts.
These guarantees are described in further detail
below.
The fair value at inception of the obligation
undertaken when issuing the guarantees and
commitments that qualify under FIN 45 is typically
equal to the net present value of the future amount
of premium receivable under the contract. The Firm
has recorded this amount in other liabilities with
an offsetting entry recorded in other assets. As
cash is received under the contract, it is applied
to the premium receivable recorded in other assets,
and the fair value of the liability recorded at
inception is amortized into income as lending &
deposit-related fees over the life of the guarantee
contract. The amount of the liability related to
FIN 45 guarantees recorded at December 31, 2008 and
2007, excluding the allowance for lending-related commitments and derivative
contracts discussed below, was approximately $535
million and $335 million, respectively.
Asset purchase agreements
The majority of the Firm’s unfunded commitments are
not guarantees as defined in FIN 45, except for
certain asset purchase agreements that are
principally used as a mechanism to provide
liquidity to SPEs, predominantly multi-seller
conduits, as described in Note 17 on pages 177–181
of this Annual Report. The conduit’s administrative
agent can require the liquidity provider to perform
under their asset purchase agreement with the
conduit at any time. These agreements may cause the
Firm to purchase an asset from the SPE at an amount
above the asset’s then fair value, in effect
providing a guarantee of the initial value of the
reference asset as of the date of the agreement. In
most instances, third-party credit enhancements of
the SPE mitigate the Firm’s potential losses on
these agreements.
The carrying value of asset purchase agreements of
$147 million at December 31, 2008, classified in
accounts payable and other liabilities on the
Consolidated Balance Sheets, includes $9 million
for the allowance for lending-related commitments
and $138 million for the FIN 45 guarantee
liability.
Standby letters of credit
Standby letters of credit (“SBLC”) and financial guarantees
are conditional lending commitments issued by the
Firm to guarantee the performance of a customer to
a third party under certain arrangements, such as
commercial paper facilities, bond financings,
acquisition financings, trade and similar
transactions. The majority of SBLCs mature in 5 years or less; as of December 31, 2008 and 2007, 64%
and 52%, respectively, of these arrangements mature
within three years. The Firm has recourse to
recover from the customer any amounts paid under
these guarantees; in addition, the Firm may hold
cash or other highly liquid collateral to support
these guarantees. The carrying value of standby letters of credit of
$673 million and $590 million at December 31, 2008 and
2007, respectively, which is classified in accounts payable and other
liabilities in the Consolidated Balance Sheets, includes
$276 million and $255 million at December 31, 2008 and
2007, respectively for the allowance for lending-related commitments,
and $397 million and $335 million at December 31, 2008
and 2007, respectively for the FIN 45 guarantee.
The following table summarizes the type of facilities under which standby letters of credit and
other letters of credit arrangements are outstanding by the ratings profiles of the Firm’s
customers as of December 31, 2008 and 2007. The ratings scale is
representative of the
payment or performance risk to the Firm under the guarantee and is based upon the Firm’s internal risk ratings,
which generally correspond to ratings defined by S&P and Moody’s.
2008
2007
Standby letters
Standby letters
of credit and
of credit and
other financial
Other letters
other financial
Other letters
December 31, (in millions)
guarantees
of credit
guarantees
of credit
Investment-grade(a)
$
73,394
$
4,165
$
71,904
$
4,153
Noninvestment-grade(a)
21,958
762
28,318
1,218
Total contractual amount
$
95,352
(b)
$
4,927
$
100,222
(b)
$
5,371
Allowance
for lending-related commitments
$
274
$
2
$
254
$
1
Commitments with collateral
30,972
1,000
31,502
809
(a)
Ratings scale is based upon the Firm’s internal ratings
which generally correspond to ratings defined by S&P and
Moody’s.
(b)
Represents contractual amount net of risk participations totaling $28.3 billion at
both December 31, 2008 and 2007.
Derivatives qualifying as guarantees
In addition to the contracts described above, the
Firm transacts certain derivative contracts that
meet the characteristics of a guarantee under FIN
45. These contracts include written put options
that require the Firm to purchase assets upon
exercise by the option holder at a specified price
by a specified date in the future. The Firm may
enter into written put option contracts in order to
meet client needs, or for trading purposes. The
terms of written put options are typically five
years or less. Derivative guarantees also include
contracts such as stable value derivatives that
require the Firm to make a payment of the
difference between the market value and the book
value of a counterparty’s reference portfolio of
assets in the event that market
value is less than book value and certain other
conditions have been met. Stable value derivatives,
commonly referred to as “stable value wraps”, are
transacted in order to allow investors to realize
investment returns with less volatility than an
unprotected portfolio, and typically have
a longer-term maturity or allow either party to terminate the
contract subject to contractually specified terms.
Derivative guarantees are recorded on the
Consolidated Balance Sheets at fair value in
trading assets and trading liabilities. The total
notional value of the derivatives that the Firm
deems to be guarantees was $83.8 billion and $85.3
billion at December 31, 2008 and 2007,
respectively. The notional value generally
represents the Firm’s
maximum exposure to derivatives qualifying as
guarantees, although exposure to certain stable
value derivatives is contractually limited to a
substantially lower percentage of the notional
value. The fair value of the contracts reflects the
probability of whether the Firm will be required to
perform under the contract. The fair value related
to derivative guarantees was a derivative
receivable of $184 million and $213 million and a
derivative payable of $5.6 billion and $2.5 billion
at December 31, 2008 and 2007, respectively. The
Firm reduces exposures to these contracts by
entering into offsetting transactions, or by
entering into contracts that hedge the market risk
related to the derivative guarantees.
In
addition to derivative contracts that meet the characteristics of a
guarantee under FIN 45, the Firm is both a purchaser and seller of
credit protection in the credit derivatives market. For a further
discussion of credit derivatives, see Note 32 on pages 202-205 of
this Annual Report.
Securities lending indemnification
Through the Firm’s securities lending program,
customers’ securities, via custodial and
non-custodial arrangements, may be lent to third
parties. As part of this program, the Firm provides
an indemnification in the lending agreements which
protects the lender against the failure of the
third-party borrower to return the lent securities
in the event the Firm did not obtain sufficient
collateral. To minimize its liability under these
indemnification agreements, the Firm obtains cash
or other highly liquid collateral with a market
value exceeding 100% of the value of the securities
on loan from the borrower. Collateral is marked to
market daily to help assure that collateralization
is adequate. Additional collateral is called from
the borrower if a shortfall exists, or collateral
may be released to the borrower in the event of
overcollateralization. If a borrower defaults, the
Firm would use the collateral held to purchase
replacement securities in the market or to credit
the lending customer with the cash equivalent
thereof.
Also, as part of this program, the Firm invests
cash collateral received from the borrower in
accordance with approved guidelines.
Based upon historical experience, management
believes that risk of loss under its
indemnification obligations is remote.
Indemnification agreements – general
In connection with issuing securities to investors,
the Firm may enter into contractual arrangements
with third parties that may require the Firm to
make a payment to them in the event of a change in
tax law or an adverse interpretation of tax law. In
certain cases, the contract also may include a
termination clause, which would allow the Firm to
settle the contract at its fair value in lieu of
making a payment under the indemnification clause.
The Firm may also enter into indemnification
clauses in connection with the licensing of
software to clients (“software licensees”) or when
it sells a business or assets to a third party
(“third-party purchasers”), pursuant to which it
indemnifies software licensees for claims of
liability or damages that may occur subsequent to
the licensing of the software, or third-party
purchasers for losses they may incur due to actions
taken by the Firm prior to the sale of the business
or assets. It is difficult to estimate the Firm’s
maximum exposure under
these indemnification arrangements, since this
would require an assessment of future changes in
tax law and future claims that may be made against
the Firm that have not yet occurred. However, based
upon historical experience, management expects the
risk of loss to be remote.
Loan sale and securitization-related indemnifications Indemnifications for breaches of representations and warranties
As part of the Firm’s loan sale and securitization
activities, as described in Note 14 and Note 16 on
pages 163–166 and 168–176, respectively, of this
Annual Report, the Firm generally makes
representations and warranties in its loan sale and
securitization agreements that the loans sold meet
certain requirements. These agreements may require
the Firm (including in its roles as a servicer) to
repurchase the loans and/or indemnify the purchaser
of the loans against losses due to any breaches of
such representations or warranties. Generally, the
maximum amount of future payments the Firm would be
required to make for breaches under these
representations and warranties would be equal to
the current amount of assets held by such
securitization-related SPEs plus, in certain
circumstances, accrued and unpaid interest on such
loans and certain expense.
At
December 31, 2008 and 2007, the Firm had recorded a
repurchase liability of $1.1 billion and $15
million, respectively.
Loans sold with recourse
The Firm provides servicing for mortgages and
certain commercial lending products on both a
recourse and nonrecourse basis. In nonrecourse
servicing, the principal credit risk to the Firm is
the cost of temporary servicing advances of funds
(i.e., normal servicing advances). In recourse
servicing, the servicer agrees to share credit risk
with the owner of the mortgage loans, such as the
Federal National Mortgage Association or the
Federal Home Loan Mortgage Corporation or a private
investor, insurer or guarantor. Losses on
recourse servicing predominantly occur when foreclosure sales
proceeds of the property underlying a defaulted loan are less than
the sum of the outstanding principal balance, plus accrued interest
on the loan and the cost of holding and disposing of the underlying
property. The Firm’s loan sale transactions have primarily been
executed on a nonrecourse basis, thereby effectively transferring the risk of
future credit losses to the purchaser of the mortgage-backed
securities issued by the trust. At
December 31, 2008 and 2007, the unpaid principal
balance of loans sold with recourse totaled $15.0
billion and $557 million, respectively. The increase in loans
sold with recourse between December 31, 2008 and 2007, was driven
by the Washington Mutual transaction. The
carrying value of the related liability that the
Firm had recorded, which is representative of the
Firm’s view of the likelihood it will have to
perform under this guarantee, was $241 million and
zero at December 31, 2008 and 2007, respectively.
Credit card charge-backs
Prior to November 1, 2008, the Firm was a partner
with one of the leading companies in electronic
payment services in a joint venture operating under
the name of Chase Paymentech Solutions, LLC (the
“joint venture”). The joint venture was formed in
October 2005, as a result of an agreement by the
Firm and First Data Corporation, its joint venture
partner, to integrate the companies’ jointly-owned
Chase Merchant Services and Paymentech merchant
businesses. The joint venture provided merchant
processing services in the United States and
Canada. The dissolution of the joint venture
was completed on November 1, 2008, and JPMorgan
Chase retained approximately 51% of the business
under the Chase Paymentech Solutions name.
Under the rules of Visa USA, Inc., and MasterCard
International, JPMorgan Chase Bank, N.A., is liable
primarily for the amount of each processed credit
card sales transaction that is the subject of a
dispute between a cardmember and a merchant. If a
dispute is resolved in the cardmember’s favor,
Chase Paymentech Solutions will (through the
cardmember’s issuing bank) credit or refund the
amount to the cardmember and will charge back the
transaction to the merchant. If Chase Paymentech
Solutions is unable to collect the amount from the
merchant, Chase Paymentech Solutions will bear the loss for
the amount credited or refunded to the cardmember.
Chase Paymentech Solutions mitigates this risk by
withholding future settlements, retaining cash
reserve accounts or by obtaining other security.
However, in the unlikely event that: (1) a merchant
ceases operations and is unable to deliver
products, services or a refund; (2) Chase
Paymentech Solutions does not have sufficient
collateral from the merchant to provide customer
refunds; and (3) Chase Paymentech Solutions does
not have sufficient financial resources to provide
customer refunds, JPMorgan Chase Bank, N.A., would
be liable for the amount of the transaction. For
the year ended December 31, 2008, Chase Paymentech
Solutions incurred aggregate credit losses of $13
million on $713.9 billion of aggregate volume
processed, and at December 31, 2008, it held $222
million of collateral. For the year ended December31, 2007, the joint venture incurred aggregate
credit losses of $10 million on $719.1 billion of
aggregate volume processed, and at December 31,2007, the joint venture held $779 million of
collateral. The Firm believes that, based upon
historical experience and the collateral held by
Chase Paymentech Solutions, the amount of the
Firm’s charge back-related obligations, which is
representative of the payment or performance risk
to the Firm, is immaterial.
Credit card association, exchange and
clearinghouse guarantees
The Firm holds an equity interest in VISA Inc.
During October 2007, certain VISA-related entities
completed a series of restructuring transactions to
combine their operations, including VISA USA, under
one holding company, VISA Inc. Upon the
restructuring, the Firm’s membership interest in
VISA USA was converted into an equity interest in
VISA Inc. VISA Inc. sold shares via an initial
public offering and used a portion of the proceeds
from the offering to redeem a portion of the Firm’s
equity interest in Visa Inc. Prior to the
restructuring, VISA USA’s by-laws obligated the
Firm upon demand by VISA USA to indemnify VISA USA
for, among other things, litigation obligations of
Visa USA. The accounting for that guarantee was not
subject to fair value accounting under FIN 45,
because the guarantee was in effect prior to the
effective date of FIN 45. Upon the restructuring
event, the Firm’s obligation to indemnify Visa Inc.
was limited to certain identified litigations. Such
a limitation is deemed a modification of the
indemnity by-law and, accordingly, is now subject
to the provisions of FIN 45. The value of the
litigation guarantee has been recorded in the
Firm’s financial statements based on its fair
value; the net amount recorded (within other
liabilities) did not have a material adverse effect
on the Firm’s financial statements.
In addition to Visa, the Firm is a member of other
associations, including several securities and
futures exchanges and clearinghouses, both in the
United States and other countries. Membership in
some of these organizations requires the Firm to
pay a pro rata share of the losses incurred by the
organization as a result of the default of another
member. Such obligations vary with different
organizations. These obligations may be limited to
members who dealt with the defaulting member or to
the amount (or a multiple of the amount) of the
Firm’s contribution to a member’s guarantee fund,
or, in a few cases, the obligation may be
unlimited. It is difficult to estimate the Firm’s
maximum exposure under these membership agreements,
since this would require an assessment of future
claims that may be made against the Firm that have
not yet occurred. However, based upon historical
experience, management expects the risk of loss to
be remote.
Residual value guarantee
In connection with the Bear Stearns merger, the
Firm succeeded to an operating lease arrangement
for the building located at 383 Madison Avenue in
New York City (the “Synthetic Lease”). Under the
terms of the Synthetic Lease, the Firm is obligated
to make periodic payments based on the lessor’s
underlying interest costs. The Synthetic Lease
expires on November 1, 2010. Under the terms of the
Synthetic Lease, the Firm has the right to purchase
the building for the amount of the then outstanding
indebtedness of the lessor, or to arrange for the
sale of the building, with the proceeds of the sale
to be used to satisfy the lessor’s debt obligation.
If the sale does not generate sufficient proceeds
to satisfy the lessor’s debt obligation, the Firm
is required to fund the shortfall up to a maximum
residual value guarantee. As of December 31, 2008,
there was no expected shortfall, and the maximum
residual value guarantee was approximately $670
million. Under a separate ground lease, the land on
which the building is built was leased to an
affiliate of Bear Stearns which, as part of the
Synthetic Lease, assigned this position to the
Synthetic Lease lessor. The owner of the land sued
the Firm, alleging that certain provisions of the
merger agreement violated a “right of first offer”
provision of the ground lease. The Firm’s motion to
dismiss the lawsuit was granted, and a judgment of
dismissal was entered on January 12, 2009. The
owner has filed a notice of appeal.
Note 34 – Credit risk concentrations
Concentrations of credit risk arise when a
number of customers are engaged in similar
business activities or activities in the same
geographic region, or when they have similar
economic features that would cause their ability
to meet contractual obligations to be similarly
affected by changes in economic conditions.
JPMorgan Chase regularly monitors various segments
of its credit portfolio to assess potential
concentration risks and to obtain collateral when
deemed necessary. Senior management is
significantly involved in the credit approval and
review process, and risk levels are adjusted as
needed to reflect management’s risk tolerance.
In the Firm’s wholesale portfolio, risk
concentrations are evaluated primarily by industry
and geographic region, and monitored regularly
on both an aggregate portfolio level and
on an individual customer basis. Management of the
Firm’s wholesale exposure is accomplished through
loan syndication and participation, loan sales,
securitizations, credit derivatives, use of master
netting agreements, and collateral and other
risk-reduction techniques. In the consumer
portfolio, concentrations are evaluated primarily
by product and by U.S. geographic region, with a
key focus on trends and concentrations at the
portfolio level, where potential risk
concentrations can be remedied through changes in
underwriting policies and portfolio guidelines.
The Firm does not believe exposure to any one loan
product with varying terms (e.g., interest-only
payments for an introductory period, option ARMs)
or exposure to loans with high loan-to-value ratios
would result in a significant concentration of
credit risk. Terms of loan products and collateral
coverage are included in the Firm’s assessment when
extending credit and establishing its allowance for
loan losses.
For further information regarding on-balance sheet
credit concentrations by major product and
geography, see Note 14 on pages 163–166 and Note
15 on pages 166–168 of this Annual Report. For
information regarding concentrations of off-balance
sheet lending-related financial instruments by
major product, see Note 33 on pages 206–210 of
this Annual Report.
The table below presents both on- and off-balance sheet wholesale- and consumer-related credit
exposure as of December 31, 2008 and 2007.
2008
2007
On-balance sheet
On-balance sheet
Credit
Off-balance
Credit
Off-balance
December 31, (in millions)
exposure
Loans
Derivatives
sheet(c)
exposure
Loans
Derivatives
sheet(c)
Wholesale-related:
Real estate
$
83,799
$
66,881
$
2,289
$
14,629
$
38,295
$
20,274
$
893
$
17,128
Banks and finance companies
75,577
19,055
33,457
23,065
65,288
16,776
12,502
36,010
Asset managers
49,256
9,640
18,806
20,810
38,554
8,534
7,763
22,257
Healthcare
38,032
7,004
3,723
27,305
30,746
5,644
885
24,217
State & municipal governments
35,954
5,873
9,427
20,654
31,425
5,699
3,205
22,521
Utilities
34,246
9,184
4,664
20,398
28,679
5,840
1,870
20,969
Retail & consumer services
32,714
8,433
3,079
21,202
23,969
6,665
517
16,787
Consumer products
29,766
10,081
2,225
17,460
29,941
8,915
1,084
19,942
Securities firms & exchanges
25,590
6,360
14,111
5,119
23,274
5,120
11,022
7,132
Oil & gas
24,746
8,796
2,220
13,730
26,082
10,348
1,570
14,164
Insurance
17,744
1,942
5,494
10,308
16,782
1,067
2,442
13,273
Technology
17,555
5,028
1,361
11,166
18,335
4,674
1,309
12,352
Media
17,254
7,535
1,248
8,471
16,253
4,909
1,268
10,076
Central government
15,259
555
10,537
4,167
9,075
583
3,989
4,503
Metals/mining
14,980
6,470
1,991
6,519
17,714
7,282
2,673
7,759
All other wholesale
278,114
75,252
47,994
154,868
298,803
77,097
24,144
197,562
Loans held-for-sale and loans at
fair value
13,955
13,955
—
—
23,649
23,649
—
—
Receivables from customers(a)
16,141
—
—
—
—
—
—
—
Total wholesale-related
820,682
262,044
162,626
379,871
736,864
213,076
77,136
446,652
Consumer-related:
Home equity
238,633
142,890
—
95,743
169,023
94,832
—
74,191
Prime mortgage
99,200
94,121
—
5,079
47,382
39,988
—
7,394
Subprime mortgage
22,090
22,090
—
—
15,489
15,473
—
16
Option ARMs
40,661
40,661
—
—
—
—
—
—
Auto loans
47,329
42,603
—
4,726
50,408
42,350
—
8,058
Credit card(b)
728,448
104,746
—
623,702
799,200
84,352
—
714,848
All other loans
45,972
33,715
—
12,257
36,743
25,314
—
11,429
Loans held-for-sale
2,028
2,028
—
—
3,989
3,989
—
—
Total consumer-related
1,224,361
482,854
—
741,507
1,122,234
306,298
—
815,936
Total exposure
$
2,045,043
$
744,898
$
162,626
$
1,121,378
$
1,859,098
$
519,374
$
77,136
$
1,262,588
(a)
Primarily represents margin loans to prime and retail brokerage customers which
are included in accrued interest and accounts receivable on the Consolidated Balance
Sheets.
(b)
Excludes $85.6 billion and $72.7 billion of securitized credit card receivables at
December 31, 2008 and 2007, respectively.
The following table presents income statement
information of JPMorgan Chase by major
international geographic area. The Firm defines
international activities as business transactions
that involve customers residing outside of the
U.S., and the information presented below is based
primarily upon the domicile of the customer or the
location from which the customer relationship is
managed. However, many of the Firm’s U.S.
operations serve international businesses.
As the Firm’s operations are highly integrated,
estimates and subjective assumptions have been made
to apportion revenue and expense between U.S. and
international operations. These estimates and
assumptions are consistent with the allocations
used for the Firm’s segment reporting as set forth
in Note 37 on pages 214–215 of this Annual Report.
The Firm’s long-lived assets for the periods
presented are not considered by management to be
significant in relation to total assets. The
majority of the Firm’s long-lived assets are
located in the United States.
Income (loss) from continuing
operations before
Year ended December 31, (in millions)
Revenue(a)
Expense(b)
income tax expense
(benefit)
Net income
2008
Europe/Middle East and Africa
$
11,449
$
8,403
$
3,046
$
2,483
Asia and Pacific
4,097
3,580
517
672
Latin America and the Caribbean
1,353
903
450
274
Other
499
410
89
21
Total international
17,398
13,296
4,102
3,450
Total U.S.
49,854
51,183
(1,329
)
2,155
Total
$
67,252
$
64,479
$
2,773
$
5,605
2007
Europe/Middle East and Africa
$
12,070
$
8,445
$
3,625
$
2,585
Asia and Pacific
4,730
3,117
1,613
945
Latin America and the Caribbean
2,028
975
1,053
630
Other
407
289
118
79
Total international
19,235
12,826
6,409
4,239
Total U.S.
52,137
35,741
16,396
11,126
Total
$
71,372
$
48,567
$
22,805
$
15,365
2006
Europe/Middle East and Africa
$
11,342
$
7,471
$
3,871
$
2,774
Asia and Pacific
3,227
2,649
578
400
Latin America and the Caribbean
1,342
820
522
333
Other
381
240
141
90
Total international
16,292
11,180
5,112
3,597
Total U.S.
45,707
30,933
14,774
10,847
Total
$
61,999
$
42,113
$
19,886
$
14,444
(a)
Revenue is composed of net interest income and noninterest revenue.
(b)
Expense is composed of noninterest expense and provision for credit losses.
Excess tax benefits related to
stock-based compensation
148
365
302
Proceeds from issuance of
common stock
11,969
1,467
1,659
Proceeds from issuance of preferred
stock and warrant to the U.S. Treasury
25,000
—
—
Proceeds from issuance of
preferred stock (e)
8,098
—
—
Redemption of preferred stock
—
—
(139
)
Repurchases of treasury stock
—
(8,178
)
(3,938
)
Cash dividends paid
(5,911
)
(5,051
)
(4,846
)
Net cash provided by financing
activities
113,772
52,111
8,642
Net (decrease) increase in cash and due
from banks
(75
)
(646
)
295
Cash and due from banks
at the beginning of the year, primarily
with bank subsidiaries
110
756
461
Cash and due from banks at the end
of the year, primarily with bank
subsidiaries
$
35
$
110
$
756
Cash interest paid
$
7,485
$
7,470
$
5,485
Cash income taxes paid
156
5,074
3,599
(a)
Subsidiaries include trusts that issued guaranteed capital debt securities
(“issuer trusts”). As a result of FIN 46R, the Parent
Company deconsolidated these trusts in 2003.
The Parent Company received dividends of $15 million, $18 million and $23 million from the issuer
trusts in 2008, 2007 and 2006, respectively. For further discussion on these issuer
trusts, see Note 23 on page 191 of this Annual Report.
(b)
Amounts for 2007 have been revised to reflect the pushdown of certain litigation expense,
which had previously been recorded at the parent company level, to the bank
subsidiary level.
There was no change to net income as the increase in Parent Company profitability was
offset by a decrease in the net income of subsidiaries.
(c)
At December 31, 2008, debt that contractually matures in 2009 through 2013 totaled
$25.8 billion, $28.6 billion, $29.3 billion, $25.3 billion and $11.8 billion,
respectively.
(d)
Includes $39.8 billion of Bear Stearns’ long-term debt assumed by JPMorgan Chase &
Co.
(e)
Includes the conversion of Bear Stearns’ preferred stock into JPMorgan Chase
preferred stock.
JPMorgan Chase is organized into six major
reportable business segments — Investment Bank,
Retail Financial Services, Card Services,
Commercial Banking, Treasury & Securities Services
and Asset Management, as well as a
Corporate/Private Equity segment. The segments are
based upon the products and services provided or
the type of
customer served, and they reflect the manner in
which financial information is currently evaluated
by management. Results of these lines of business
are presented on a managed basis. For a definition
of managed basis, see Explanation and
Reconciliation of the Firm’s use of non-GAAP
financial measures, on pages 38–39 of this Annual
Report. For a further discussion concerning
JPMorgan Chase’s business segments, see Business
segment results on pages 40–41 of this Annual
Report.
Segment results
The following table provides a summary of the Firm’s segment results for 2008, 2007 and 2006 on a
managed basis. The impact of credit card securitizations and tax-equivalent adjustments have been
included in Reconciling items so that the total Firm results are on a reported basis.
Segment results and reconciliation(a) (table continued on next page)
Year ended December 31,
Investment Bank
Retail Financial Services
Card Services
Commercial Banking
(in millions, except ratios)
2008
2007
2006
2008
2007
2006
2008
2007
2006
2008
2007
2006
Noninterest revenue
$
1,930
$
14,094
$
18,334
$
9,355
$
6,779
$
4,660
$
2,719
$
3,046
$
2,944
$
1,481
$
1,263
$
1,073
Net interest income
10,284
4,076
499
14,165
10,526
10,165
13,755
12,189
11,801
3,296
2,840
2,727
Total net revenue
12,214
18,170
18,833
23,520
17,305
14,825
16,474
15,235
14,745
4,777
4,103
3,800
Provision for credit losses
2,015
654
191
9,905
2,610
561
10,059
5,711
4,598
464
279
160
Credit reimbursement
(to)/from TSS(b)
121
121
121
—
—
—
—
—
—
—
—
—
Noninterest expense(c)
13,844
13,074
12,860
12,077
9,905
8,927
5,140
4,914
5,086
1,946
1,958
1,979
Income (loss) from
continuing operations
before income tax
expense (benefit)
(3,524
)
4,563
5,903
1,538
4,790
5,337
`1,275
4,610
5,061
2,367
1,866
1,661
Income tax expense (benefit)
(2,349
)
1,424
2,229
658
1,865
2,124
495
1,691
1,855
928
732
651
Income (loss) from
continuing operations
(1,175
)
3,139
3,674
880
2,925
3,213
780
2,919
3,206
1,439
1,134
1,010
Income from discontinued
operations
—
—
—
—
—
—
—
—
—
—
—
—
Income (loss) before
extraordinary gain
(1,175
)
3,139
3,674
880
2,925
3,213
780
2,919
3,206
1,439
1,134
1,010
Extraordinary gain(d)
—
—
—
—
—
—
—
—
—
—
—
—
Net income (loss)
$
(1,175
)
$
3,139
$
3,674
$
880
$
2,925
$
3,213
$
780
$
2,919
$
3,206
$
1,439
$
1,134
$
1,010
Average common equity
$
26,098
$
21,000
$
20,753
$
19,011
$
16,000
$
14,629
$
14,326
$
14,100
$
14,100
$
7,251
$
6,502
$
5,702
Average assets
832,729
700,565
647,569
304,442
241,112
231,566
173,711
155,957
148,153
114,299
87,140
57,754
Return on average
common equity
(5
)%
15
%
18
%
5
%
18
%
22
%
5
%
21
%
23
%
20
%
17
%
18
%
Overhead ratio
113
72
68
51
57
60
31
32
34
41
48
52
(a)
In addition to analyzing the Firm’s results on a reported basis, management
reviews the Firm’s results and the results of the lines of business on a “managed basis,”
which is a non-GAAP financial measure. The Firm’s definition of managed basis starts with
the reported U.S. GAAP results and includes certain reclassifications that do not have any
impact on net income as reported by the lines of business or by the Firm as a whole.
(b)
TSS is charged a credit reimbursement related to certain exposures managed
within IB credit portfolio on behalf of clients shared with TSS.
(c)
Includes merger costs which are reported in the Corporate/Private Equity
segment. Merger costs attributed to the business segments for 2008, 2007 and 2006 were as
follows.
Year ended December 31, (in millions)
2008
2007
2006
Investment Bank
$
183
$
(2
)
$
2
Retail Financial Services
90
14
24
Card Services
20
(1
)
29
Commercial Banking
4
(1
)
1
Treasury & Securities Services
—
121
117
Asset Management
3
20
23
Corporate/Private Equity
132
58
109
(d)
On September 25, 2008, JPMorgan Chase acquired the banking operations of
Washington Mutual from the FDIC for $1.9 billion. The fair value of the net assets
acquired exceeded the purchase price, which resulted in negative goodwill. In accordance
with SFAS 141, nonfinancial assets that are not held-for-sale, such as premises and
equipment and other intangibles, acquired in the Washington Mutual transaction were
written down against that negative goodwill. The negative goodwill that remained after
writing down nonfinancial assets was recognized as an extraordinary gain.
(e)
Included a $1.5 billion charge to conform Washington Mutual’s loan loss reserve
to JPMorgan Chase’s allowance methodology.
Line of business equity increased during the
second quarter of 2008 in IB and AM due to the Bear
Stearns merger and, for AM, the purchase of the
additional equity interest in Highbridge. At the
end of the third quarter of 2008, equity was
increased for each line of business with a view
toward the future implementation of the new Basel
II capital rules. In addition, equity allocated to
RFS, CS and CB was increased as a result of the
Washington Mutual transaction.
Discontinued operations
As a result of the transaction with The Bank of New
York, selected corporate trust businesses have been
transferred from TSS to the Corporate/Private
Equity segment and reported in discontinued
operations for all periods reported.
(table continued from previous page)
Treasury &
Asset
Reconciling
Securities Services
Management
Corporate/Private Equity
items(g)(h)
Total
2008
2007
2006
2008
2007
2006
2008
2007
2006
2008
2007
2006
2008
2007
2006
$
5,196
$
4,681
$
4,039
$
6,066
$
7,475
$
5,816
$
(278
)
$
5,056
$
1,058
$
2,004
$
2,572
$
2,833
$
28,473
$
44,966
$
40,757
2,938
2,264
2,070
1,518
1,160
971
347
(637
)
(1,044
)
(7,524
)
(6,012
)
(5,947
)
38,779
26,406
21,242
8,134
6,945
6,109
7,584
8,635
6,787
69
4,419
14
(5,520
)
(3,440
)
(3,114
)
67,252
71,372
61,999
82
19
(1
)
85
(18
)
(28
)
1,981
(e)(f)
(11
)
(1
)
(3,612
)
(2,380
)
(2,210
)
20,979
6,864
3,270
(121
)
(121
)
(121
)
—
—
—
—
—
—
—
—
—
—
—
—
5,223
4,580
4,266
5,298
5,515
4,578
(28
)
1,757
1,147
—
—
—
43,500
41,703
38,843
2,708
2,225
1,723
2,201
3,138
2,237
(1,884
)
2,673
(1,132
)
(1,908
)
(1,060
)
(904
)
2,773
22,805
19,886
941
828
633
844
1,172
828
(535
)
788
(1,179
)
(1,908
)
(1,060
)
(904
)
(926
)
7,440
6,237
1,767
1,397
1,090
1,357
1,966
1,409
(1,349
)
1,885
47
—
—
—
3,699
15,365
13,649
—
—
—
—
—
—
—
—
795
—
—
—
—
—
795
1,767
1,397
1,090
1,357
1,966
1,409
(1,349
)
1,885
842
—
—
—
3,699
15,365
14,444
—
—
—
—
—
—
1,906
—
—
—
—
—
1,906
—
—
$
1,767
$
1,397
$
1,090
$
1,357
$
1,966
$
1,409
$
557
$
1,885
$
842
$
—
$
—
$
—
$
5,605
$
15,365
$
14,444
$
3,751
$
3,000
$
2,285
$
5,645
$
3,876
$
3,500
$
53,034
$
54,245
$
49,728
$
—
$
—
$
—
$
129,116
$
118,723
$
110,697
54,563
53,350
31,760
65,550
51,882
43,635
323,227
231,818
218,623
(76,904
)
(66,780
)
(65,266
)
1,791,617
1,455,044
1,313,794
47
%
47
%
48
%
24
%
51
%
40
%
NM
NM
NM
NM
NM
NM
4
%(i)
13
%
13
%(i)
64
66
70
70
64
67
NM
NM
NM
NM
NM
NM
65
58
63
(f)
In November 2008, the Firm transferred $5.8 billion of
higher quality credit card loans from the legacy Chase portfolio to a
securitization trust previously established by Washington Mutual
(“the Trust”). As a result of converting higher credit
quality Chase-originated on-book receivables to the Trust’s
seller’s interest which has a higher overall loss rate
reflective of the total assets within the Trust, approximately
$400 million of incremental provision expense was recorded
during the fourth quarter. This incremental provision expense was
recorded in the Corporate segment as the action related to the
acquisition of Washington Mutual’s banking operations. For
further discussion of credit card securitizations, see Note 16 on
pages 169-170 of this Annual Report.
(g)
Managed results for credit card exclude the impact of CS
securitizations on total net revenue, provision for credit losses and average assets, as
JPMorgan Chase treats the sold receivables as if they were still on the balance sheet in
evaluating the credit performance of the entire managed credit card portfolio as
operations are funded, and decisions are made about allocating resources such as
employees and capital, based upon managed information. These adjustments are eliminated in
reconciling items to arrive at the Firm’s reported U.S. GAAP results. The related
securitization adjustments were as follows.
Year ended December 31, (in millions)
2008
2007
2006
Noninterest revenue
$
(3,333
)
$
(3,255
)
$
(3,509
)
Net interest income
6,945
5,635
5,719
Provision for credit losses
3,612
2,380
2,210
Average assets
76,904
66,780
65,266
(h)
Segment managed results reflect revenue on a tax-equivalent basis with the
corresponding income tax impact recorded within income tax expense
(benefit). These adjustments are
eliminated in reconciling items to arrive at the Firm’s reported U.S. GAAP results.
Tax-equivalent adjustments for the years ended December 31, 2008, 2007 and 2006 were as
follows.
(in millions, except per share, ratio and headcount data)
2008(i)
2007
As of or for the period ended
4th
3rd
2nd
1st
4th
3rd
2nd
1st
Selected income statement data
Noninterest revenue(a)
$
3,394
$
5,743
$
10,105
$
9,231
$
10,161
$
9,199
$
12,740
$
12,866
Net interest income
13,832
8,994
8,294
7,659
7,223
6,913
6,168
6,102
Total net revenue
17,226
14,737
18,399
16,890
17,384
16,112
18,908
18,968
Provision for credit losses
7,755
3,811
3,455
4,424
2,542
1,785
1,529
1,008
Provision for credit losses – accounting
conformity(b)
(442
)
1,976
—
—
—
—
—
—
Total noninterest expense
11,255
11,137
12,177
8,931
10,720
9,327
11,028
10,628
Income (loss) before income tax expense
(benefit) and extraordinary gain
(1,342
)
(2,187
)
2,767
3,535
4,122
5,000
6,351
7,332
Income tax expense (benefit)
(719
)
(2,133
)
764
1,162
1,151
1,627
2,117
2,545
Income (loss) before extraordinary gain
(623
)
(54
)
2,003
2,373
2,971
3,373
4,234
4,787
Extraordinary gain(c)
1,325
581
—
—
—
—
—
—
Net income
$
702
$
527
$
2,003
$
2,373
$
2,971
$
3,373
$
4,234
$
4,787
Per common share
Basic earnings
Income (loss) before extraordinary gain
$
(0.28
)
$
(0.06
)
$
0.56
$
0.70
$
0.88
$
1.00
$
1.24
$
1.38
Net income
0.07
0.11
0.56
0.70
0.88
1.00
1.24
1.38
Diluted earnings
Income (loss) before extraordinary gain
$
(0.28
)
$
(0.06
)
$
0.54
$
0.68
$
0.86
$
0.97
$
1.20
$
1.34
Net income
0.07
0.11
0.54
0.68
0.86
0.97
1.20
1.34
Cash dividends declared per share
0.38
0.38
0.38
0.38
0.38
0.38
0.38
0.34
Book value per share
36.15
36.95
37.02
36.94
36.59
35.72
35.08
34.45
Common shares outstanding
Average: Basic
3,738
3,445
3,426
3,396
3,367
3,376
3,415
3,456
Diluted
3,738
(h)
3,445
(h)
3,531
3,495
3,472
3,478
3,522
3,560
Common shares at period end
3,733
3,727
3,436
3,401
3,367
3,359
3,399
3,416
Share price(d)
High
$
50.63
$
49.00
$
49.95
$
49.29
$
48.02
$
50.48
$
53.25
$
51.95
Low
19.69
29.24
33.96
36.01
40.15
42.16
47.70
45.91
Close
31.53
46.70
34.31
42.95
43.65
45.82
48.45
48.38
Market capitalization
117,695
174,048
117,881
146,066
146,986
153,901
164,659
165,280
Financial ratios
Return on common equity:
Income (loss) before extraordinary gain
(3
)%
(1
)%
6
%
8
%
10
%
11
%
14
%
17
%
Net income
1
1
6
8
10
11
14
17
Return on assets:
Income (loss) before extraordinary gain
(0.11
)
(0.01
)
0.48
0.61
0.77
0.91
1.19
1.41
Net income
0.13
0.12
0.48
0.61
0.77
0.91
1.19
1.41
Tier 1 capital ratio
10.9
8.9
9.2
8.3
8.4
8.4
8.4
8.5
Total capital ratio
14.8
12.6
13.4
12.5
12.6
12.5
12.0
11.8
Tier 1 leverage ratio
6.9
7.2
6.4
5.9
6.0
6.0
6.2
6.2
Overhead ratio
65
76
66
53
62
58
58
56
Selected balance sheet data (period-end)
Trading assets
$
509,983
$
520,257
$
531,997
$
485,280
$
491,409
$
453,711
$
450,546
$
423,331
Securities
205,943
150,779
119,173
101,647
85,450
97,706
95,984
97,029
Loans
744,898
761,381
538,029
537,056
519,374
486,320
465,037
449,765
Total assets
2,175,052
2,251,469
1,775,670
1,642,862
1,562,147
1,479,575
1,458,042
1,408,918
Deposits
1,009,277
969,783
722,905
761,626
740,728
678,091
651,370
626,428
Long-term debt
252,094
238,034
260,192
189,995
183,862
173,696
159,493
143,274
Common stockholders’ equity
134,945
137,691
127,176
125,627
123,221
119,978
119,211
117,704
Total stockholders’ equity
166,884
145,843
133,176
125,627
123,221
119,978
119,211
117,704
Headcount
224,961
228,452
195,594
182,166
180,667
179,847
179,664
176,314
Credit quality metrics
Allowance for credit losses
$
23,823
$
19,765
$
13,932
$
12,601
$
10,084
$
8,971
$
8,399
$
7,853
Nonperforming assets(e)(f)
12,714
9,520
6,233
5,143
3,933
3,009
2,423
2,212
Allowance for loan losses to total loans(g)
3.18
%
2.56
%
2.57
%
2.29
%
1.88
%
1.76
%
1.71
%
1.74
%
Net charge-offs
$
3,315
$
2,484
$
2,130
$
1,906
$
1,429
$
1,221
$
985
$
903
Net charge-off rate(g)
1.80
%
1.91
%
1.67
%
1.53
%
1.19
%
1.07
%
0.90
%
0.85
%
Wholesale net charge-off (recovery) rate(g)
0.33
0.10
0.08
0.18
0.05
0.19
(0.07
)
(0.02
)
Consumer net charge-off rate(g)
2.59
3.13
2.77
2.43
1.93
1.62
1.50
1.37
Managed card net charge-off rate
5.56
5.00
4.98
4.37
3.89
3.64
3.62
3.57
(a)
The Firm adopted SFAS 157 in the first quarter of 2007. See Note 4 on pages
129–143 of this Annual Report for additional information.
(b)
For a discussion of accounting conformity, see provision for
credit losses on page 35 and consumer credit portfolio
discussion on page 91.
(c)
For a discussion of the extraordinary gain, see Note 2 on pages 123–128.
(d)
JPMorgan Chase’s common stock is listed and traded on the New York Stock Exchange,
the London Stock Exchange and the Tokyo Stock Exchange. The high, low and closing
prices of JPMorgan Chase’s common stock are from The New York Stock Exchange Composite
Transaction Tape.
(e)
Excludes purchased wholesale loans held-for-sale.
(f)
During the second quarter of 2008, the policy for classifying subprime mortgage
and home equity loans as nonperforming was changed to conform to all other home lending
products. Amounts for 2007 have been revised to reflect this change.
(g)
End-of-period and average loans held-for-sale and loans at fair value were
excluded when calculating the allowance coverage ratios and net charge-off rates,
respectively.
(h)
Common equivalent shares have been excluded from the
computation of diluted earnings per share for the third quarter of
2008, as the effect on income (loss) before extraordinary gain would
be antidilutive.
(i)
On September 25, 2008, JPMorgan Chase acquired the banking
operations of Washington Mutual Bank. On May 30, 2008, the Bear
Stearns merger was consummated. Each of these transactions was
accounted for as a purchase and their respective results of
operations are included in the Firm’s results from each
respective transaction date. For additional information on these
transactions, see Note 2 on pages 123-128 of this Annual Report.
Provision for credit losses – accounting conformity(b)
1,534
—
—
—
858
Total noninterest expense
43,500
41,703
38,843
38,926
34,336
Income from continuing operations before income tax expense
(benefit)
2,773
22,805
19,886
11,839
5,856
Income tax expense (benefit)
(926
)
7,440
6,237
3,585
1,596
Income from continuing operations
3,699
15,365
13,649
8,254
4,260
Income from discontinued operations(c)
—
—
795
229
206
Income before extraordinary gain
3,699
15,365
14,444
8,483
4,466
Extraordinary gain(d)
1,906
—
—
—
—
Net income
$
5,605
$
15,365
$
14,444
$
8,483
$
4,466
Per common share
Basic earnings per share
Income from continuing operations
$
0.86
$
4.51
$
3.93
$
2.36
$
1.51
Net income
1.41
4.51
4.16
2.43
1.59
Diluted earnings per share
Income from continuing operations
$
0.84
$
4.38
$
3.82
$
2.32
$
1.48
Net income
1.37
4.38
4.04
2.38
1.55
Cash dividends declared per share
1.52
1.48
1.36
1.36
1.36
Book value per share
36.15
36.59
33.45
30.71
29.61
Common shares outstanding
Average: Basic
3,501
3,404
3,470
3,492
2,780
Diluted
3,605
3,508
3,574
3,557
2,851
Common shares at period end
3,733
3,367
3,462
3,487
3,556
Share price(e)
High
$
50.63
$
53.25
$
49.00
$
40.56
$
43.84
Low
19.69
40.15
37.88
32.92
34.62
Close
31.53
43.65
48.30
39.69
39.01
Market capitalization
117,695
146,986
167,199
138,387
138,727
Financial ratios
Return on common equity:
Income from continuing operations
2
%
13
%
12
%
8
%
6
%
Net income
4
13
13
8
6
Return on assets:
Income from continuing operations
0.21
1.06
1.04
0.70
0.44
Net income
0.31
1.06
1.10
0.72
0.46
Tier 1 capital ratio
10.9
8.4
8.7
8.5
8.7
Total capital ratio
14.8
12.6
12.3
12.0
12.2
Tier 1 leverage ratio
6.9
6.0
6.2
6.3
6.2
Overhead ratio
65
58
63
72
80
Selected balance sheet data (period-end)
Trading assets
$
509,983
$
491,409
$
365,738
$
298,377
$
288,814
Securities
205,943
85,450
91,975
47,600
94,512
Loans
744,898
519,374
483,127
419,148
402,114
Total assets
2,175,052
1,562,147
1,351,520
1,198,942
1,157,248
Deposits
1,009,277
740,728
638,788
554,991
521,456
Long-term debt
252,094
183,862
133,421
108,357
95,422
Common stockholders’ equity
134,945
123,221
115,790
107,072
105,314
Total stockholders’ equity
166,884
123,221
115,790
107,211
105,653
Headcount
224,961
180,667
174,360
168,847
160,968
Credit quality metrics
Allowance for credit losses
$
23,823
$
10,084
$
7,803
$
7,490
$
7,812
Nonperforming assets(f)(g)
12,714
3,933
2,341
2,590
3,231
Allowance for loan losses to total loans(h)
3.18
%
1.88
%
1.70
%
1.84
%
1.94
%
Net charge-offs
$
9,835
$
4,538
$
3,042
$
3,819
$
3,099
Net charge-off rate(h)
1.73
%
1.00
%
0.73
%
1.00
%
1.08
%
Wholesale net charge-off (recovery) rate(h)
0.18
0.04
(0.01
)
(0.06
)
0.18
Consumer net charge-off rate(h)
2.71
1.61
1.17
1.56
1.56
Managed card net charge-off rate
5.01
3.68
3.33
5.21
5.27
(a)
The Firm adopted SFAS 157 in the first quarter of 2007. See Note 4 on pages
129–143 of this Annual Report for additional information.
(b)
For a discussion of accounting conformity, see provision for
credit losses on page 35 and consumer credit portfolio
discussion on page 91.
(c)
On October 1, 2006, JPMorgan Chase & Co. completed the exchange of selected
corporate trust businesses for the consumer, business banking and middle-market banking
businesses of The Bank of New York Company Inc. The results of operations of these
corporate trust businesses are reported as discontinued operations for each period prior
to 2007.
(d)
For a discussion of the extraordinary gain, see Note 2 on pages 123–128.
(e)
JPMorgan Chase’s common stock is listed and traded on the New York Stock Exchange,
the London Stock Exchange and the Tokyo Stock Exchange. The high, low and closing prices
of JPMorgan Chase’s common stock are from The New York Stock Exchange Composite
Transaction Tape.
(f)
Excludes purchased wholesale loans held-for-sale.
(g)
During the second quarter of 2008, the policy for classifying subprime mortgage
and home equity loans as nonperforming was changed to conform to all other home lending
products. Amounts for 2007 have been revised to reflect this change.
Periods prior to 2007 have not been revised as the impact was
not material.
(h)
End-of-period and average loans held-for-sale and loans at fair value were
excluded when calculating the allowance coverage ratios and net charge-off rates,
respectively.
(i)
On September 25, 2008, JPMorgan Chase acquired the banking
operations of Washington Mutual Bank. On May 30, 2008, the Bear
Stearns merger was consummated. Each of these transactions was
accounted for as a purchase and their respective results of
operations are included in the Firm’s results from each
respective transaction date. For additional information on these
transactions, see Note 2 on pages 123-128 of this Annual Report.
(j)
On July 1, 2004, Bank One Corporation merged with and into JPMorgan Chase.
Accordingly, 2004 results include six months of the combined Firm’s results and six months
of heritage JPMorgan Chase results.
Advised lines of credit: An authorization which
specifies the maximum amount of a credit facility
the Firm has made available to an obligor on a
revolving but non-binding basis. The borrower
receives written or oral advice of this facility.
The Firm may cancel this facility at any time.
AICPA: American Institute of Certified Public Accountants.
AICPA Statement of Position (“SOP”) 03-3:“Accounting for Certain Loans or Debt Securities
Acquired in a Transfer.”
AICPA SOP 07-1: “Clarification of the Scope of the
Audit and Accounting Guide Investment Companies
and Accounting by Parent Companies and Equity
Method Investors for Investments in Investment
Companies.”
AICPA SOP 98-1: “Accounting for the Costs of
Computer Software Developed or Obtained for
Internal Use.”
Alternative assets: The following types of assets
constitute alternative investments – hedge funds,
currency, real estate and private equity.
APB 18: Accounting Principles Board Opinion No.
18, “The Equity Method of Accounting for
Investments in Common Stock.”
APB 25: Accounting Principles Board Opinion No.
25, “Accounting for Stock Issued to Employees.”
Assets under management: Represent assets actively
managed by Asset Management on behalf of
Institutional, Retail, Private Banking, Private
Wealth Management and Bear Stearns Brokerage
clients. Excludes assets managed by American
Century Companies, Inc., in which the Firm has a
43% ownership interest as of December 31, 2008.
Assets under supervision: Represent assets under
management as well as custody, brokerage,
administration and deposit accounts.
Average managed assets: Refers to total assets on
the Firm’s Consolidated Balance Sheets plus
credit card receivables that have been
securitized.
Beneficial interest issued by consolidated VIEs:
Represents the interest of third-party holders of
debt/equity securities, or other obligations,
issued by VIEs that JPMorgan Chase consolidates
under FIN 46R. The underlying obligations of the
VIEs consist of short-term borrowings, commercial
paper and long-term debt. The related assets
consist of trading assets, available-for-sale
securities, loans and other assets.
Benefit obligation: Refers to the projected benefit
obligation for pension plans and the accumulated
postretirement benefit obligation for OPEB plans.
Combined effective loan-to-value ratio: For
residential real estate loans, an indicator of
how much equity a borrower has in a secured
borrowing based on current estimates of the value
of the collateral and considering all lien
positions related to the property.
Contractual credit card charge-off: In accordance
with the Federal Financial Institutions
Examination Council policy, credit card loans are
charged off by the end of the month in which the
account becomes 180 days past due or within 60
days from receiving notification of the filing of
bankruptcy, whichever is earlier.
Credit card securitizations: Card Services’ managed
results excludes the impact of credit card
securitizations on total net revenue, the provision
for credit losses, net charge-offs and loan
receivables. Through securitization, the Firm
transforms a portion of its credit card receivables
into securities, which are sold to investors. The
credit card receivables are removed from the
Consolidated Balance Sheets through the transfer of
the receivables to a trust, and through the sale of
undivided interests to investors that entitle the
investors to specific cash flows generated from the
credit card receivables. The Firm retains the
remaining undivided interests as seller’s
interests, which are recorded in loans on the
Consolidated Balance Sheets. A gain or loss on the
sale of credit card receivables to investors is
recorded in other income. Securitization also
affects the Firm’s Consolidated Statements of
Income, as the aggregate amount of interest income,
certain fee revenue and recoveries that is in
excess of the aggregate amount of interest paid to
investors, gross credit losses and other trust
expense related to the securitized receivables are
reclassified into credit card income in the
Consolidated Statements of Income.
Credit derivatives: Contractual agreements that
provide protection against a credit event on one or
more referenced credits. The nature of a credit
event is established by the protection buyer and
protection seller at the inception of a
transaction, and such events include bankruptcy,
insolvency or failure to meet payment obligations
when due. The buyer of the credit derivative pays a
periodic fee in return for a payment by the
protection seller upon the occurrence, if any, of a
credit event.
Credit cycle: A period of time over which credit
quality improves, deteriorates and then improves
again. The duration of a credit cycle can vary
from a couple of years to several years.
Deposit margin: Represents net interest income
on deposits expressed as a percentage of
average deposits.
Discontinued operations: A component of an entity
that is classified as held-for-sale or that has
been disposed of from ongoing operations in its
entirety or piecemeal, and for which the entity
will not have any
significant, continuing involvement. A discontinued
operation may be a separate major business segment,
a component of a major business segment or a
geographical area of operations of the entity that
can be separately distinguished operationally and
for financial reporting purposes.
EITF: Emerging Issues Task Force.
EITF Issue 06-11: “Accounting for Income Tax
Benefits of Dividends on Share-Based Payment
Awards.”
EITF Issue 02-3: “Issues Involved in Accounting for
Derivative Contracts Held for Trading Purposes and
Contracts Involved in Energy Trading and Risk
Management Activities.”
EITF Issue 99-20: “Recognition of Interest
Income and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial
Assets.”
FASB: Financial Accounting Standards Board.
FICO: Fair Isaac Corporation.
FIN 39: FASB Interpretation No. 39, “Offsetting of
Amounts Related to Certain Contracts – an
interpretation of APB Opinion No. 10 and FASB
Statement No. 105.”
FIN 41: FASB Interpretation No. 41, “Offsetting of
Amounts Related to Certain Repurchase and Reverse
Repurchase Agreements – an interpretation of APB
Opinion No. 10 and a Modification of FASB
Interpretation No. 39.”
FIN 45: FASB Interpretation No. 45, “Guarantor’s
Accounting and Disclosure Requirements for
Guarantees, including Indirect Guarantees of
Indebtedness of Others – an interpretation of
FASB Statements No. 5, 57 and 107 and a
rescission of FASB
Interpretation No. 34.”
FIN 46R: FASB Interpretation No. 46 (revised
December 2003), “Consolidation of Variable
Interest Entities – an interpretation of ARB
No. 51.”
FIN 47: FASB Interpretation No. 47, “Accounting
for Conditional Asset Retirement Obligations – an
interpretation of FASB Statement No. 143.”
FIN 48: FASB Interpretation No. 48, “Accounting
for Uncertainty in Income Taxes – an
interpretation of FASB Statement No. 109.”
Forward points: Represents the interest rate
differential between two currencies, which is
either added to or subtracted from the current
exchange rate (i.e., “spot rate”) to determine the
forward exchange rate.
FSP: FASB Staff Position.
FSP FAS 123(R)-3: “Transition Election Related to
Accounting for the Tax Effects of Share-Based
Payment Awards.”
FSP FAS 132(R)-1: “Employers’ Disclosures about
Postretirement Benefit Plan Assets.”
FSP FAS 133-1 and FIN 45-4: “Disclosures about
Credit Derivatives and Certain Guarantees: An
Amendment of FASB Statement No. 133 and FASB
Interpretation No. 45; and Clarification of the
Effective Date of FASB Statement No. 161.”
FSP FAS 140-4 and FIN 46(R)-8: “Disclosures by
Public Entities (Enterprises) about Transfers of
Financial Assets and Interests in Variable
Interest Entities.”
FSP EITF 03-6-1: “Determining Whether
Instruments Granted in Share-Based Payment
Transactions Are Participating Securities.”
FSP FAS 140-3: “Accounting for Transfers of
Financial Assets and Repurchase Financing
Transactions.”
FSP FIN 39-1: “Amendment of FASB Interpretation No. 39.”
FSP FIN 46(R)-7: “Application of FASB
Interpretation No. 46(R) to Investment Companies.”
Interchange income: A fee that is paid to a
credit card issuer in the clearing and settlement
of a sales or cash advance transaction.
Interests in purchased receivables: Represent an
ownership interest in cash flows of an underlying
pool of receivables transferred by a third-party
seller into a bankruptcy-remote entity, generally a
trust.
Investment-grade: An indication of credit quality
based upon JPMorgan Chase’s internal risk
assessment system. “Investment-grade” generally
represents a risk profile similar to a rating of a
“BBB-”/“Baa3” or better, as defined by independent
rating agencies.
Managed basis: A non-GAAP presentation of financial
results that includes reclassifications related to
credit card securitizations and to present revenue
on a fully taxable-equivalent basis. Management
uses this non-GAAP financial measure at the segment
level, because it believes this provides
information to enable investors to understand the
underlying operational performance and trends of
the particular business segment and facilitates a
comparison of the business segment with the
performance of competitors.
Managed credit card receivables: Refers to credit
card receivables on the Firm’s Consolidated
Balance Sheets plus credit card receivables that
have been securitized.
Mark-to-market exposure: A measure, at a point in
time, of the value of a derivative or foreign
exchange contract in the open market. When the
mark-to-market value is positive, it indicates the
counterparty owes JPMorgan Chase and, therefore,
creates a repayment risk for the Firm. When the
mark-to-market value is negative, JPMorgan Chase
owes the counterparty; in
this situation, the Firm does not have repayment
risk.
Master netting agreement: An agreement between two
counterparties that have multiple derivative
contracts with each other that provides for the net
settlement of all contracts through a single
payment, in a single currency, in the event of
default on or termination of any one contract. See
FIN 39.
Mortgage product types:
Alt-A
Alt-A loans are generally higher in credit quality
than subprime loans but have characteristics that
would disqualify the borrower from a traditional
prime loan. Alt-A lending characteristics may
include one or more of the following: (i) limited
documentation; (ii) high combined-loan-to-value
(“CLTV”) ratio; (iii) loans secured by non-owner
occupied properties; or (iv) debt-to-income ratio
above normal limits. Perhaps the most important
characteristic is limited documentation. A
substantial proportion of traditional Alt-A loans
are those where a borrower does not provide
complete documentation of his or her assets or the
amount or source of his or her income.
Option ARMs
The option ARM home loan product is an
adjustable-rate mortgage loan that provides the
borrower with the option each month to make
a fully amortizing, interest-only, or minimum
payment. The minimum payment on an option ARM loan
is based upon the interest rate charged during the
introductory period. This introductory rate has
usually been significantly below the fully indexed
rate. The fully indexed rate is calculated using an
index rate plus a margin. Once the introductory
period ends, the contractual interest rate charged
on the loan increases to the fully indexed rate and
adjusts monthly to reflect movements in the index.
The minimum payment is typically insufficient to
cover interest accrued in the prior month, and any
unpaid interest is deferred and added to the
principal balance of the loan.
Prime
Prime mortgage loans generally have low default
risk and are made to borrowers with good credit
records and a monthly income that is at least
three to four times greater than their monthly
housing expense (mortgage payments plus taxes and
other debt payments). These borrowers provide full
documentation and generally have reliable payment
histories.
Subprime
Subprime loans are designed for customers with one
or more high risk characteristics, including but
not limited to: (i) unreliable or poor payment
histories; (ii) high loan-to-value (“LTV”) ratio of
greater than 80% (without borrower-paid mortgage
insurance); (iii) high debt-to-income ratio; (iv)
the occupancy type for the loan is
other than the borrower’s primary residence; or (v)
a history of delinquencies or late payments on the
loan.
MSR risk management revenue: Includes changes in
MSR asset fair value due to inputs or assumptions
in model and derivative valuation adjustments.
Material legal proceedings: Refers to certain
specific litigation originally discussed in the
section “Legal Proceedings” in the Firm’s Annual
Report on Form 10-K for the year ended December 31,2002. Of such legal proceedings, some lawsuits
related to Enron and the IPO allocation allegations
remain outstanding as of the date of this Annual
Report, as discussed in Part I, Item 3, legal
proceedings in the Firm’s Annual Report on Form
10-K for the year ended December 31, 2008, to which
reference is hereby made; other such legal
proceedings have been resolved.
NA: Data is not applicable or available for the period presented.
Net yield on interest-earning assets: The average
rate for interest-earning assets less the average
rate paid for all sources of funds.
NM: Not meaningful.
Nonconforming mortgage loans: Mortgage loans that
do not meet the requirements for sale to U.S.
government agencies and U.S. government sponsored
enterprises. These requirements include limits on
loan-to-value ratios, loan terms, loan amounts,
down payments, borrower creditworthiness and other
requirements.
OPEB: Other postretirement employee benefits.
Overhead ratio: Noninterest expense as a
percentage of total net revenue.
Personal bankers: Retail branch office personnel
who acquire, retain and expand new and existing
customer relationships by assessing customer needs
and recommending and selling appropriate banking
products and services.
Portfolio activity: Describes changes to the risk
profile of existing lending-related exposures and
their impact on the allowance for credit losses
from changes in customer profiles and inputs used
to estimate the allowances.
Principal transactions: Realized and unrealized
gains and losses from trading activities (including
physical commodities inventories that are accounted
for at the lower of cost or fair value) and changes
in fair value associated with financial instruments
held by the Investment Bank for which the SFAS 159
fair value option was elected. Principal
transactions revenue also include private equity
gains and losses.
Purchased credit-impaired loans: Acquired loans
deemed to be credit-impaired under SOP 03-3. SOP
03-3 allows purchasers to aggregate
credit-impaired loans acquired in the same fiscal
quarter into one or more pools, provided that the
loans have common risk characteristics (e.g., FICO
score, geographic location).
A pool is then accounted for as a single asset
with a single composite interest rate and an
aggregate expectation of cash flows. Wholesale
loans were determined to be credit-impaired if
they met the definition of an impaired loan under
SFAS 114 at the acquisition date. Consumer loans
are determined to be purchased credit-impaired
based upon specific risk characteristics of the
loan, including product type, loan-to-value
ratios, FICO scores, and past due status.
Receivables from customers: Primarily represents
margin loans to prime and retail brokerage
customers which are included in accrued interest
and accounts receivable on the Consolidated
Balance Sheets for the wholesale lines of
business.
REMIC: Investment vehicles that hold commercial
and residential mortgages in trust and issues
securities representing an undivided interest in
these mortgages. A REMIC, which can be a
corporation, trust, association, or partnership,
assembles mortgages into pools and issues
pass-through certificates, multiclass bonds
similar to a collateralized mortgage obligation
(“CMO”) or other securities to investors in the
secondary mortgage market.
Reported basis: Financial statements prepared under
accounting principles generally accepted in the
United States of America (“U.S. GAAP”). The
reported basis includes the impact of credit card
securitizations but excludes the impact of
taxable-equivalent adjustments.
Return on common equity less goodwill: Represents
net income applicable to common stock divided by
total average common equity (net of goodwill). The
Firm uses return on common equity less goodwill, a
non-GAAP financial measure, to evaluate the
operating performance of the Firm. The Firm also
utilizes this measure to facilitate operating
comparisons to other competitors.
Risk layered loans: Loans with multiple high risk elements.
SAB 105: “Application of Accounting
Principles to Loan Commitments.”
SAB 109: “Written Loan Commitments Recorded at
Fair Value Through Earnings.”
Sales specialists: Retail branch office personnel
who specialize in the marketing of a single
product, including mortgages, investments, and
business banking, by partnering with the personal
bankers.
SFAS: Statement of Financial Accounting Standards.
SFAS 5: “Accounting for Contingencies.”
SFAS 13: “Accounting for Leases.”
SFAS 52: “Foreign Currency Translation.”
SFAS 87: “Employers’ Accounting for Pensions.”
SFAS 88: “Employers’ Accounting for Settlements
and Curtailments of Defined Benefit Pension Plans
and for Termination Benefits.”
SFAS 106: “Employers’ Accounting for Postretirement
Benefits Other Than Pensions.”
SFAS 107: “Disclosures about Fair Value of Financial Instruments.”
SFAS 109: “Accounting for Income Taxes.”
SFAS 114: “Accounting by Creditors for Impairment
of a Loan – an amendment of FASB Statements No. 5
and 15.”
SFAS 115: “Accounting for Certain Investments
in Debt and Equity Securities.”
SFAS 123: “Accounting for Stock-Based
Compensation.”
SFAS 123R: “Share-Based
Payment.”
SFAS 128: “Earnings per Share.”
SFAS 133: “Accounting for Derivative
Instruments and Hedging Activities.”
SFAS 138: “Accounting for Certain Derivative
Instruments and Certain Hedging Activities – an
amendment of FASB Statement No. 133.”
SFAS 140: “Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of
Liabilities – a replacement of FASB Statement
No. 125.”
SFAS 141: “Business Combinations.”
SFAS 141R: “Business Combinations.”
SFAS 142: “Goodwill and Other Intangible Assets.”
SFAS 143: “Accounting for Asset Retirement Obligations.”
SFAS 149: “Amendment of Statement No. 133 on
Derivative Instruments and Hedging
Activities.”
SFAS 155: “Accounting for Certain Hybrid
Financial Instruments – an amendment of FASB
Statements No. 133 and 140.”
SFAS 156: “Accounting for Servicing of
Financial Assets – an amendment of FASB
Statement No. 140.”
SFAS 157: “Fair Value Measurements.”
SFAS 158: “Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans –
an amendment of FASB Statements No. 87, 88, 106,
and 132(R).”
SFAS 159: “The Fair Value Option for Financial
Assets and Financial Liabilities – Including an
amendment of FASB Statement No. 115.”
SFAS 160: “Noncontrolling Interests in
Consolidated Financial Statements – an
amendment of ARB No. 51.”
SFAS 161: “Disclosures About Derivative
Instruments and Hedging Activities – an amendment
of FASB Statement No. 133.”
Stress testing: A scenario that measures market
risk under unlikely but plausible events in
abnormal markets.
Unaudited: Financial statements and information
that have not been subjected to auditing
procedures sufficient to permit an independent
certified public accountant to express an
opinion.
U.S. GAAP: Accounting principles generally
accepted in the United States of America.
U.S. government and federal agency obligations:
Obligations of the U.S. government or an
instrumentality of the U.S. government whose
obligations are fully and explicitly guaranteed as
to the timely payment of principal and interest by
the full faith and credit of the U.S. government.
U.S. government-sponsored enterprise obligations:
Obligations of agencies originally established or
chartered by the U.S. government to serve public
purposes as specified by the U.S.
Congress; these obligations are not explicitly
guaranteed as to the timely payment of principal
and interest by the full faith and credit of the
U.S. government.
Value-at-risk (“VaR”): A measure of the dollar
amount of potential loss from adverse market moves
in an ordinary market environment.
Distribution of assets, liabilities and stockholders’ equity;
interest rates and interest differentials
Consolidated average balance sheet, interest and rates
Provided below is a summary of JPMorgan Chase’s
consolidated average balances, interest rates and
interest differentials on a taxable-equivalent
basis for the years 2006 through 2008. Income
computed on a taxable-equivalent basis is the
income reported in the
Consolidated Statements of Income, adjusted to make
income and earnings yields on assets exempt from
income taxes (primarily federal taxes) comparable
with other taxable income. The incremental tax rate
used for calculating the taxable-equivalent
adjustment was
(Table continued on next page)
2008(d)
Year ended December 31,
Average
Average
(Taxable-equivalent interest and rates; in millions, except rates)
balance
Interest
rate
Assets
Deposits with banks
$
54,666
$
1,916
3.51
%
Federal funds sold and securities purchased under resale agreements
170,006
5,983
3.52
Securities borrowed
110,598
2,297
2.08
Trading
assets – debt instruments
298,266
17,556
5.89
Securities
123,551
6,447
5.22
(g)
Interests in purchased receivables
—
—
—
Loans
588,801
38,503
(f)
6.54
Other assets(a)
27,404
895
3.27
Total interest-earning assets
1,373,292
73,597
5.36
Allowance for loan losses
(13,477
)
Cash and due from banks
30,323
Trading
assets – equity instruments
85,836
Trading
assets – derivative receivables
121,417
Goodwill
46,068
Other intangible assets
Mortgage servicing rights
11,229
Purchased credit card relationships
1,976
All other intangibles
3,803
All other assets
131,150
Assets of discontinued operations held-for-sale(b)
—
Total assets
$
1,791,617
Liabilities
Interest-bearing deposits
$
645,058
$
14,546
2.26
%
Federal funds purchased and securities loaned or sold under
repurchase agreements
196,739
4,668
2.37
Commercial paper
45,734
1,023
2.24
Other borrowings and liabilities(c)
161,555
5,242
3.24
Beneficial interests issued by consolidated VIEs
13,220
405
3.06
Long-term debt
234,909
8,355
3.56
Total interest-bearing liabilities
1,297,215
34,239
2.64
Noninterest-bearing deposits
140,749
Trading
liabilities – derivative payables
93,200
All other liabilities, including the allowance for lending-related
commitments
122,199
Liabilities of discontinued operations held-for-sale(b)
—
Total liabilities
1,653,363
Stockholders’ equity
Preferred stock
9,138
Common stockholders’ equity
129,116
Total stockholders’ equity
138,254
(e)
Total liabilities, preferred stock of subsidiary and stockholders’
equity
$
1,791,617
Interest rate spread
2.72
%
Net interest income and net yield on interest-earning assets
$
39,358
2.87
(a)
Includes margin loans and the Firm’s investment in asset-backed commercial paper
under the Federal Reserve Bank of Boston’s AML facility.
(b)
For purposes of the consolidated average balance sheet for assets and liabilities
transferred to discontinued operations, JPMorgan Chase used federal funds sold interest
income as a reasonable estimate of the earnings on corporate trust deposits; therefore,
JPMorgan Chase transferred to assets of discontinued operations held-for-sale average
federal funds sold, along with the related interest income earned, and transferred to
liabilities of discontinued operations held-for-sale average corporate trust deposits.
(c)
Includes securities sold but not yet purchased, brokerage customer payables and
advances from federal home loan banks.
(d)
On September 25, 2008, JPMorgan Chase acquired the
banking operations of Washington Mutual Bank. On May 30, 2008,
the Bear Stearns merger was consummated. Each of
these transactions was accounted for as a purchase and their
respective results of operations are included in the Firm’s results
from each respective transaction date. For additional information on
these transactions, see Note 2 on pages 123-128.
(e)
The ratio of average stockholders’ equity to average assets was 7.7% for 2008,
8.2% for 2007 and 8.4% for 2006. The return on average stockholders’ equity was 4.1% for
2008, 12.9% for 2007 and 13.0% for 2006.
(f)
Fees and commissions on loans included in loan interest amounted to $2.0 billion
in 2008, $1.7 billion in 2007 and $1.2 billion in 2006.
(g)
The annualized rate for available-for-sale securities based on amortized cost was
5.17% in 2008, 5.64% in 2007, and 5.49% in 2006, and does not give effect to changes in
fair value that are reflected in accumulated other comprehensive
income (loss).
approximately 40% in 2008, 2007 and 2006. A
substantial portion of JPMorgan Chase’s securities
are taxable.
Within the Consolidated average balance sheets,
interest and rates summary, the principal amounts
of nonaccrual loans have been
included in the average loan balances used to
determine the average interest rate earned on
loans. For additional information on nonaccrual
loans, including interest accrued, see Note 14 on
pages 163–166.
Interest rates and interest differential analysis of net interest income – U.S. and
non-U.S.
Presented below is a summary of interest rates
and interest differentials segregated between U.S.
and non-U.S. operations for the years 2006 through
2008. The segregation of U.S. and non-U.S.
components
is based on the location of the office
recording the transaction. Intracompany funding
generally comprises dollar-denominated deposits
originated in various locations that are centrally
managed
(Table continued on next page)
2008(b)
Year ended December 31,
Average
Average
(Taxable-equivalent interest and rates; in millions, except rates)
balance
Interest
rate
Interest-earning assets:
Deposits with banks, primarily non-U.S.
$
54,666
$
1,916
3.51
%
Federal funds sold and securities purchased under resale agreements:
U.S.
95,301
3,084
3.24
Non-U.S.
74,705
2,899
3.88
Securities borrowed:
U.S.
60,592
985
1.63
Non-U.S.
50,006
1,312
2.62
Trading assets – debt instruments:
U.S.
169,447
9,614
5.67
Non-U.S.
128,819
7,942
6.17
Securities:
U.S.
108,663
5,859
5.39
Non-U.S.
14,888
588
3.95
Interests in purchased receivables, primarily U.S.
—
—
—
Loans:
U.S.
506,513
33,570
6.63
Non-U.S.
82,288
4,933
5.99
Other assets, primarily U.S.
27,404
895
3.27
Total interest-earning assets
$
1,373,292
$
73,597
5.36
%
Interest-bearing liabilities:
Interest-bearing deposits:
U.S.
$
407,699
$
8,420
2.07
%
Non-U.S.
237,359
6,126
2.58
Federal funds purchased and securities loaned or sold under
repurchase agreements:
U.S.
158,054
3,326
2.10
Non-U.S.
38,685
1,342
3.47
Other borrowings and liabilities:
U.S.
161,509
3,390
2.10
Non-U.S.
45,780
2,875
6.28
Beneficial interests issued by consolidated VIEs, primarily U.S.
13,220
405
3.06
Long-term debt, primarily U.S.
234,909
8,355
3.56
Intracompany funding:
U.S.
(17,637
)
(927
)
—
Non-U.S.
17,637
927
—
Total interest-bearing liabilities
1,297,215
34,239
2.64
Noninterest-bearing liabilities(a)
76,077
Total investable funds
$
1,373,292
$
34,239
2.49
%
Net interest income and net yield:
$
39,358
2.87
%
U.S.
31,651
3.24
Non-U.S.
7,707
1.95
Percentage of total assets and liabilities attributable
to non-U.S. operations:
Assets
30.4
Liabilities
28.0
(a)
Represents the amount of noninterest-bearing liabilities funding interest-earning
assets.
(b)
On September 25, 2008, JPMorgan Chase acquired the banking operations of
Washington Mutual Bank. On May 30, 2008, the Bear Stearns
merger was consummated. Each of these transactions was accounted for as a purchase and their
respective results of operations are included in the Firm’s results from each respective
transaction date. For additional information on these transactions, see Note 2 on pages
123–128.
by JPMorgan Chase’s Treasury unit. U.S. net interest income was
$31.7 billion in 2008, an increase of $10.6
billion from the prior year. Net interest income
from non-U.S. operations was $7.7 billion for
2008, an increase of $1.9 billion from $5.8
billion in 2007.
(Continuation of table)
For further information, see the “Net interest
income” discussion in Consolidated Results of
Operations on page 34.
Changes in net interest income, volume and rate analysis
The table below presents an analysis of the effect on net interest income of volume and rate
changes for the periods 2008 versus 2007 and 2007 versus 2006. In this analysis, the change due to
the volume/rate variance has been allocated to volume.
2008 versus 2007
2007 versus 2006
Increase (decrease) due to change in:
Net
Increase (decrease) due to change in:
Net
(On a taxable equivalent basis; in millions)
Volume
Rate
change
Volume
Rate
change
Interest-earning assets
Deposits with banks, primarily non-U.S.
$
898
$
(400
)
$
498
$
61
$
92
$
153
Federal funds sold and securities
purchased under resale agreements:
U.S.
770
(1,358
)
(588
)
245
(220
)
25
Non-U.S.
408
(334
)
74
(56
)
950
894
Securities borrowed:
U.S.
334
(1,821
)
(1,487
)
239
385
624
Non-U.S.
100
(855
)
(755
)
(70
)
583
513
Trading assets – debt instruments:
U.S.
1,223
(844
)
379
3,711
53
3,764
Non-U.S.
(991
)
927
(64
)
1,538
819
2,357
Securities:
U.S.
1,416
(412
)
1,004
822
82
904
Non-U.S.
79
(23
)
56
145
34
179
Interests in purchased receivables,
primarily U.S.
—
—
—
(652
)
—
(652
)
Loans:
U.S.
6,173
(5,086
)
1,087
876
2,132
3,008
Non-U.S.
972
(238
)
734
879
(219
)
660
Other assets, primarily U.S.
895
—
895
—
—
—
Change in interest income
12,277
(10,444
)
1,833
7,738
4,691
12,429
Interest-bearing liabilities
Interest-bearing deposits:
U.S.
1,100
(6,321
)
(5,221
)
1,525
565
2,090
Non-U.S.
1,431
(3,317
)
(1,886
)
1,912
609
2,521
Federal funds purchased and securities
loaned or
sold under repurchase agreements:
U.S.
206
(4,706
)
(4,500
)
602
495
1,097
Non-U.S.
(308
)
(309
)
(617
)
51
450
501
Other borrowings and liabilities:
U.S.
1,783
(2,290
)
(507
)
1,082
(553
)
529
Non-U.S.
(542
)
957
415
(458
)
387
(71
)
Beneficial interests issued by
consolidated VIEs,
primarily U.S.
The table below presents the amortized cost, estimated fair value and average yield (including
the impact of related derivatives) of JPMorgan Chase’s securities by range of contractual maturity
and type of security.
Maturity schedule of available-for-sale and held-to-maturity securities
(in millions, rates on a taxable-equivalent basis)
year or less
through 5 years
through 10 years
10 years(d)
Total
U.S. government and federal agency obligations:
Amortized cost
$
229
$
112
$
188
$
6,994
$
7,523
Fair value
229
111
186
7,149
7,675
Average yield(a)
0.20
%
1.56
%
2.19
%
5.24
%
4.95
%
U.S. government-sponsored enterprise obligations:
Amortized cost
$
5
$
5,046
$
5,261
$
107,765
$
118,077
Fair value
5
5,018
5,231
109,813
120,067
Average yield(a)
4.48
%
2.87
%
3.82
%
5.26
%
5.09
%
Other:(b)
Amortized cost
$
23,929
$
20,957
$
7,656
$
31,186
$
83,728
Fair value
23,822
19,946
7,019
27,380
78,167
Average yield(a)
2.83
%
2.37
%
3.80
%
4.95
%
3.61
%
Total available-for-sale securities:(c)
Amortized cost
$
24,163
$
26,115
$
13,105
$
145,945
$
209,328
Fair value
24,056
25,075
12,436
144,342
205,909
Average yield(a)
2.80
%
2.46
%
3.78
%
5.19
%
4.49
%
Total held-to-maturity securities:(c)
Amortized cost
$
—
$
—
$
31
$
3
$
34
Fair value
—
—
32
3
35
Average yield(a)
—
%
—
%
6.89
%
5.69
%
6.78
%
(a)
The average yield was based on amortized cost balances at the end of the year and
does not give effect to changes in fair value that are reflected in accumulated other
comprehensive income (loss). Yields are derived by dividing interest income (including the
effect of related derivatives on available-for-sale securities and the amortization of
premiums and accretion of discounts) by total amortized cost. Taxable-equivalent yields
are used where applicable.
(b)
Includes certificates of deposit, debt securities issued by non-U.S. governments,
corporate debt securities, mortgage-backed securities, asset-backed securities and other
debt and equity securities.
(c)
For the amortized cost of the above categories of securities at December 31, 2007,
see Note 12 on page 159. At December 31, 2006, the amortized cost of U.S. government and
federal agency obligations was $2.5 billion, U.S. government-sponsored enterprise
obligations was $75.4 billion and other available-for-sale securities was $14.0 billion.
At December 31, 2006, the amortized cost of U.S. government and federal agency obligations
and U.S. government-sponsored enterprise obligations held-to-maturity securities was $58
million. There were no other held-to-maturity securities at December 31, 2006.
(d)
Securities with no stated maturity are included with securities with a contractual
maturity of ten years or more. Substantially all of JPMorgan Chase’s mortgaged-backed
securities (“MBSs”) and collateralized mortgage obligations (“CMOs”) are due in ten years
or more based on contractual maturity. The estimated duration, which reflects anticipated
future prepayments based on a consensus of dealers in the market, is approximately four
years for MBSs and CMOs.
U.S. government-sponsored enterprises were the
only issuers whose securities exceeded 10% of
JPMorgan Chase’s total stockholders’ equity at
December 31, 2008.
For a further discussion of JPMorgan Chase’s
securities portfolios, see Note 12 on pages
158–162.
The table below presents loans with the line of business basis that is presented in Credit Risk
Management on pages 82, 83 and 92, and in Note 14 on page 164, at the periods indicated. Prior
periods have been changed to reflect this presentation.
December 31, (in millions)
2008
2007(c)
2006(c)
2005(c)
2004(c)
U.S. wholesale loans:
Commercial and industrial
$
72,422
$
69,038
$
47,101
$
43,140
$
46,960
Real estate
64,450
17,190
18,787
17,170
15,670
Financial institutions
20,953
15,113
15,632
13,681
14,080
Government agencies
5,919
5,770
4,964
3,709
1,529
Other
23,032
26,142
32,202
34,365
21,629
Total U.S. wholesale loans
186,776
133,253
118,686
112,065
99,868
Non-U.S. wholesale loans:
Commercial and industrial
35,251
33,829
22,332
18,545
13,341
Real estate
2,859
3,632
2,371
1,393
2,063
Financial institutions
17,552
17,245
19,174
8,093
6,959
Government agencies
602
720
2,543
1,296
2,611
Other
19,004
24,397
18,636
8,719
10,225
Total non-U.S. wholesale loans
75,268
79,823
65,056
38,046
35,199
Total wholesale loans:
Commercial and industrial
107,673
102,867
69,433
61,685
60,301
Real estate
67,309
20,822
21,158
18,563
17,733
Financial institutions
38,505
32,358
34,806
21,774
21,039
Government agencies
6,521
6,490
7,507
5,005
4,140
Other
42,036
50,539
50,838
43,084
31,854
Total wholesale loans
262,044
213,076
183,742
150,111
135,067
Total consumer loans:
Home equity
142,890
94,832
85,730
73,866
67,612
Mortgage
157,078
56,031
59,668
58,959
56,116
Auto loans
42,603
42,350
41,009
46,081
58,906
Credit card receivables
104,746
84,352
85,881
71,738
64,575
Other
35,537
28,733
27,097
18,393
19,838
Total consumer loans
482,854
306,298
299,385
269,037
267,047
Total loans(a)(b)
$
744,898
$
519,374
$
483,127
$
419,148
$
402,114
Memo:
Loans held-for-sale
$
8,287
$
18,899
$
55,251
$
34,150
$
24,462
Loans at fair value
7,696
8,739
—
—
—
Total loans held-for-sale and
loans at fair value
$
15,983
$
27,638
$
55,251
$
34,150
$
24,462
(a)
Loans are presented net of unearned income and net deferred loan fees of $694
million, $1.0 billion, $1.3 billion, $3.0 billion and $4.1 billion at December 31, 2008,
2007, 2006, 2005 and 2004, respectively.
(b)
As a result of the adoption of SFAS 159, at January 1, 2007, certain loans are
accounted for at fair value and reported in trading assets and therefore, such loans are
no longer included in loans at December 31, 2007.
(c)
The reporting categories have been modified to reflect the industry categories and client domicile consistent with the reporting provided in the credit risk management section
on pages 80-99. Prior periods have been revised to reflect the current presentation.
Maturities and sensitivity to changes in interest rates
The table below shows, at December 31, 2008, the maturity of the
wholesale loan portfolio, and the distribution between fixed
and floating interest rates based upon the stated terms of the wholesale loan agreements. The
current view has been modified to show the portfolio on the same basis that is presented in Credit Risk
Management on pages 82, 83, and 92, and in Note 14 on page 164. The table does not include the
impact of derivative instruments.
The following table sets forth nonperforming assets and contractually
past-due assets, with the presentation in Credit Risk Management on pages
82, 83 and 92. Periods prior to 2007 have been changed to reflect this presentation.
December 31, (in millions)
2008
2007(d)
2006(d)
2005(d)
2004(d)
Nonperforming assets
U.S. nonaccrual loans:(a)
Wholesale
Commercial and industrial
$
1,052
$
63
$
238
$
555
$
908
Real estate
806
216
18
44
26
Financial institutions
60
10
5
87
17
Government agencies
—
1
—
3
1
Other
205
200
49
130
276
Consumer
6,571
2,768
(e)
1,686
1,351
1,169
Total U.S. nonaccrual loans
8,694
3,258
1,996
2,170
2,397
Non-U.S. nonaccrual loans:(a)
Wholesale
Commercial and industrial
45
14
41
105
269
Real estate
—
—
—
—
2
Financial institutions
115
8
24
51
43
Government agencies
—
—
—
3
—
Other
99
2
16
14
32
Consumer
—
—
—
—
—
Total U.S. nonaccrual loans
259
24
81
173
346
Total nonaccrual loans
8,953
3,282
2,077
2,343
2,743
Derivative receivables
1,079
29
36
50
241
Assets acquired in loan satisfactions
2,682
622
228
197
247
Nonperforming assets
$
12,714
$
3,933
$
2,341
$
2,590
$
3,231
Memo:
Loans held-for-sale
$
12
$
45
$
120
$
136
$
15
Loans at fair value
20
5
—
—
—
Total loans held-for-sale and loans at fair
value
$
32
$
50
$
120
$
136
$
15
Contractually past-due assets:(b)
U.S. loans
Commercial and industrial
$
30
$
7
$
5
$
6
$
—
Real estate
76
34
1
1
—
Financial institutions
—
—
—
—
—
Government agencies
—
—
—
6
—
Other
54
28
23
37
6
Consumer
3,084
1,945
1,708
1,068
998
Total U.S. loans
3,244
2,014
1,737
1,118
1,004
Total U.S. loans:
Non-U.S. loans
Commercial and industrial
—
—
—
—
—
Real estate
—
—
—
—
—
Financial institutions
—
—
—
—
—
Government agencies
—
—
—
—
—
Other
3
6
—
—
2
Consumer
28
23
16
10
—
Total non-U.S. loans
31
29
16
10
2
Total
$
3,275
$
2,043
$
1,753
$
1,128
$
1,006
Restructured loans(c)
U.S.
Commercial and industrial
$
—
$
8
$
—
$
—
$
—
Consumer
1,834
—
—
—
—
Total U.S.
1,834
8
—
—
—
Non-U.S.
Commercial and industrial
5
—
—
—
—
Consumer
—
—
—
—
—
Total Non-U.S.
5
—
—
—
—
Total
$
1,839
$
8
$
—
$
—
$
—
(a)
Excludes wholesale loans held-for-sale purchased as part of the Investment Bank’s
proprietary activities.
(b)
Represents accruing loans past-due 90 days or more as to principal and interest,
which are not characterized as nonperforming loans.
(c)
Represents troubled debt restructured loans for which concessions, such as the
reduction of interest rates or the deferral of interest or principal payments, have been
granted as a result of a deterioration in the borrowers’ financial condition as defined in
SFAS 15, “Accounting by Debtors and Creditors for Troubled Debt Restructurings”.
(d)
The reporting categories have been modified to reflect the industry categories consistent with the reporting provided in the credit risk management section on pages 80-99.
Prior periods have been revised to reflect the current presentation.
(e)
During the second quarter of 2008, the policy for classifying
subprime mortgage and home equity loans as nonperforming was changed
to conform to all other home lending products. Amounts for 2007 have
been revised to reflect this change. Periods prior to 2007 have not
been revised as the impact was not material.
For a discussion of nonperforming loans and past-due loan accounting policies, see Credit Risk
Management on pages 80–99, and Note 14 on pages 163–166.
Impact of nonperforming loans on interest income
The negative impact on interest income from nonperforming loans represents the difference between
the amount of interest income that would have been recorded on such nonperforming loans according
to their contractual terms had they been performing and the amount of interest that actually was
recognized on a cash basis. The following table sets forth this data for the years specified. The
increases in both 2008 and 2007 from the respective prior years in total negative impact on
interest income was primarily driven by the increases in nonperforming loans.
Year ended December 31, (in millions)
2008
2007(a)
2006(a)
U.S.:
Wholesale
Gross amount of interest that would have been recorded at the original rate
$
87
$
71
$
27
Interest that was recognized in income
(7
)
(5
)
(6
)
Total U.S. wholesale
80
66
21
Consumer
Gross amount of interest that would have been recorded at the original rate
584
230
(b)
129
Interest that was recognized in income
(193
)
(8
)
(20
)
Total U.S. consumer
391
222
109
Negative impact – U.S.
471
288
130
Non-U.S.:
Wholesale
Gross amount of interest that would have been recorded at the original rate
11
2
5
Interest that was recognized in income
(2
)
(1
)
—
Total non-U.S. wholesale
9
1
5
Consumer
Gross amount of interest that would have been recorded at the original rate
—
—
—
Interest that was recognized in income
—
—
—
Total non-U.S. consumer
—
—
—
Negative
impact – non-U.S.
9
1
5
Total negative impact on interest income
$
480
$
289
$
135
(a)
The reporting categories have been modified to reflect the industry categories consistent with the reporting provided in the credit risk management section on pages 80-99.
Prior periods have been revised to reflect the current presentation.
(b)
During the second quarter of 2008, the policy for classifying subprime mortgage
and home equity loans as nonperforming was changed to conform to all other home lending
products. Amounts for 2007 have been revised to reflect this change.
Amounts for 2006 have not been revised as the impact was not
material.
Cross-border outstandings
Cross-border disclosure is based upon the Federal Financial
Institutions Examination Council’s (“FFIEC”)
guidelines governing the determination of
cross-border risk. Based on FFIEC guidelines,
beginning in 2006 securities purchased under resale
agreements are allocated to a country based upon
the domicile of the counterparty. Additionally,
local foreign office commitments are included in
commitments; previously they were excluded from
commitments.
The following table lists all countries in which
JPMorgan Chase’s cross-border outstandings exceed
0.75% of consolidated assets as of the dates
specified. The disclosure includes certain
exposures that are not required under the
disclosure requirements of the SEC. The most
significant differences between the FFIEC and SEC
methodologies are: the FFIEC methodology includes
mark-to-market exposures of foreign exchange and
derivatives; net local country assets are reduced
by local country liabilities (regardless of
currency denomination); and securities purchased
under resale agreements are reported based on the
counterparty, without regard to the underlying
security collateral.
JPMorgan Chase’s total cross-border exposure tends
to fluctuate greatly, and the amount of exposure
at year-end tends to be a function of timing
rather than representing a consistent trend. For a
further discussion of JPMorgan Chase’s emerging
markets cross-border exposure, see Emerging
markets country exposure on pages 90–91.
Cross-border outstandings exceeding 0.75% of total assets
Net local
Total
country
cross-border
Total
(in millions)
December 31,
Governments
Banks
Other(a)
assets
outstandings(b)
Commitments(c)
exposure
United
Kingdom
2008
$
1,173
$
23,490
$
19,624
$
—
$
44,287
$
562,980
$
607,267
2007
324
8,245
14,450
—
23,019
475,046
498,065
2006
507
13,116
11,594
—
25,217
306,565
331,782
France
2008
$
6,666
$
25,479
$
24,665
$
28
$
56,838
$
353,074
$
409,912
2007
8,351
9,278
20,303
75
38,007
288,044
326,051
2006
5,218
7,760
12,747
575
26,300
171,407
197,707
Germany
2008
$
8,437
$
24,312
$
10,297
$
3,660
$
46,706
$
348,635
$
395,341
2007
10,095
11,468
18,656
—
40,219
284,879
325,098
2006
9,361
16,384
16,091
—
41,836
186,875
228,711
Netherlands
2008
$
1,360
$
8,645
$
19,356
$
—
$
29,361
$
132,574
$
161,935
2007
895
3,945
15,180
—
20,020
138,136
158,156
2006
1,776
9,699
17,878
—
29,353
80,337
109,690
Italy
2008
$
7,680
$
6,804
$
3,742
$
448
$
18,674
$
134,851
$
153,525
2007
5,301
5,285
5,593
1,401
17,580
120,179
137,759
2006
6,395
3,004
6,328
364
16,091
84,054
100,145
Spain
2008
$
906
$
11,867
$
4,466
$
1,161
$
18,400
$
104,956
$
123,356
2007
1,995
3,484
5,728
1,337
12,544
90,135
102,679
2006
722
3,715
5,766
1,136
11,339
55,517
66,856
Japan
2008
$
687
$
17,401
$
18,568
$
2,174
$
38,830
$
64,583
$
103,413
2007
12,895
9,687
9,138
—
31,720
49,407
81,127
2006
6,758
8,158
8,588
—
23,504
32,781
56,285
Cayman Islands
2008
$
87
$
115
$
30,869
$
—
$
31,071
$
6,843
$
37,914
2007
6
41
36,310
—
36,357
14,054
50,411
2006
20
125
21,492
—
21,637
10,626
32,263
Luxembourg
2008
$
—
$
514
$
7,863
$
—
$
8,377
$
28,611
$
36,988
2007
1,718
739
8,832
—
11,289
24,952
36,241
2006
1,396
1,860
8,592
—
11,848
15,667
27,515
Norway
2008
$
15,944
$
616
$
718
$
—
$
17,278
$
11,393
$
28,671
2007
9,727
650
690
—
11,067
8,929
19,996
2006
3,273
87
368
—
3,728
4,216
7,944
(a)
Consists primarily of commercial and industrial.
(b)
Outstandings includes loans and accrued interest receivable, interest-bearing
deposits with banks, acceptances, resale agreements, other monetary assets, cross-border
trading debt and equity instruments, mark-to-market exposure of foreign exchange and
derivative contracts and local country assets, net of local country liabilities. The
amounts associated with foreign exchange and derivative contracts are presented after
taking into account the impact of legally enforceable master netting agreements.
(c)
Commitments include outstanding letters of credit, undrawn commitments to extend
credit and the notional value of credit derivatives where JPMorgan Chase is a protection
seller.
Summary of loan and lending-related commitments loss experience
The tables below summarize the changes in the allowance for loan losses and the allowance for
lending-related commitments, during the periods indicated. For a further discussion, see Allowance
for credit losses on pages 96–99, and Note 15 on pages 166–168.
Allowance for loan losses
Year ended December 31, (in millions)
2008
2007(e)
2006(e)
2005(e)
2004(d)(e)
Balance at beginning of year
$
9,234
$
7,279
$
7,090
$
7,320
$
4,523
Addition resulting from mergers and
acquisitions(a)
2,535
—
—
—
3,123
Provision for loan losses(b)
21,237
6,538
3,153
3,575
2,883
U.S. charge-offs
Commercial and industrial
183
34
80
154
238
Real estate
217
46
10
2
1
Financial institutions
17
9
1
2
2
Government agencies
—
10
2
—
—
Other
35
81
36
64
84
Consumer
10,140
5,181
3,635
4,604
3,262
Total U.S. charge-offs
10,592
5,361
3,764
4,826
3,587
Non-U.S. charge-offs
Commercial and industrial
40
2
43
32
84
Real estate
—
—
—
—
—
Financial institutions
29
—
—
—
6
Government agencies
—
—
—
—
—
Other
—
3
14
1
128
Consumer
103
1
63
10
—
Total non-U.S. charge-offs
172
6
120
43
218
Total charge-offs
10,764
5,367
3,884
4,869
3,805
U.S. recoveries
Commercial and industrial
(60
)
(48
)
(89
)
(110
)
(87
)
Real estate
(5
)
(1
)
(4
)
(4
)
(12
)
Financial institutions
(2
)
(3
)
(4
)
(6
)
(8
)
Government agencies
—
—
—
—
—
Other
(29
)
(40
)
(48
)
(46
)
(93
)
Consumer
(793
)
(716
)
(622
)
(717
)
(349
)
Total U.S. recoveries
(889
)
(808
)
(767
)
(883
)
(549
)
Non-U.S. recoveries
Commercial and industrial
(16
)
(8
)
(26
)
(122
)
(55
)
Real estate
—
—
—
—
—
Financial institutions
—
(1
)
(11
)
(7
)
(19
)
Government agencies
—
—
—
(15
)
(27
)
Other
(7
)
(12
)
(26
)
(22
)
(56
)
Consumer
(17
)
—
(12
)
(1
)
—
Total non-U.S. recoveries
(40
)
(21
)
(75
)
(167
)
(157
)
Total recoveries
(929
)
(829
)
(842
)
(1,050
)
(706
)
Net charge-offs
9,835
4,538
3,042
3,819
3,099
Allowance related to purchased portfolios
6
—
75
17
—
Change in accounting principles
—
(56
)
—
—
—
Other
(13
)
11
3
(3
)
(110
)(c)
Balance at year-end
$
23,164
$
9,234
$
7,279
$
7,090
$
7,320
(a)
The 2008 amount relates to the Washington Mutual transaction and 2004 amount relates
to the merger with Bank One.
(b)
While the provision for loan losses increased during 2004 and 2005 due to the July
2004 Bank One merger, the allowance for loan losses as a percentage of total loans
declined from 2004 through 2006 as a result of a relatively benign credit environment.
Deteriorating credit conditions in 2007 and 2008, primarily within
consumer lending, resulted in increasing losses and correspondingly higher loan loss provisions for those
periods. For a more detailed discussion of the 2006 through 2008 provision for credit
losses, see Provision for Credit Losses on page 99.
(c)
Primarily relates to the transfer of the allowance for accrued interest and fees
on reported and securitized credit card loans in 2004.
(d)
On July 1, 2004, Bank One Corporation merged with and into JPMorgan Chase.
Accordingly, 2004 results include six months of the combined Firm’s results and six months
of heritage JPMorgan Chase results.
(e)
The reporting categories have been modified to reflect the industry categories consistent with the reporting provided in the credit risk management section on pages 80-99.
Prior periods have been revised to reflect the current presentation.
Allowance for lending-related commitments
Year ended December 31, (in millions)
2008
2007
2006
2005
2004(b)
Balance at beginning of year
$
850
$
524
$
400
$
492
$
324
Addition resulting from mergers and
acquisitions(a)
66
—
—
—
508
Provision for lending-related commitments
(258
)
326
117
(92
)
(339
)
Net charge-offs
—
—
—
—
—
Other
1
—
7
—
(1
)
Balance at year-end
$
659
$
850
$
524
$
400
$
492
(a)
The 2008 amount relates to the Washington Mutual transaction and 2004 amount relates
to the merger with Bank One.
(b)
On July 1, 2004, Bank One Corporation merged with and into JPMorgan Chase.
Accordingly, 2004 results include six months of the combined Firm’s results and six months
of heritage JPMorgan Chase results.
Year ended December 31, (in millions, except ratios)
2008(c)
2007
2006
2005
2004(e)
Balances
Loans – average
$
588,801
$
479,679
$
454,535
$
409,988
$
308,249
Loans – year-end
744,898
519,374
483,127
419,148
402,114
Net charge-offs(a)
9,835
4,538
3,042
3,819
3,099
Allowance for loan losses:
U.S.
21,830
8,454
6,654
6,642
6,617
Non-U.S.
1,334
780
625
448
703
Total allowance for loan losses
23,164
9,234
7,279
7,090
7,320
Nonperforming loans
8,953
3,282
(d)
2,077
2,343
2,743
Ratios
Net charge-offs to:
Loans – average(b)
1.73
%
1.00
%
0.73
%
1.00
%
1.08
%
Allowance for loan losses
42.46
49.14
41.79
53.86
42.34
Allowance for loan losses to:
Loans – year-end(b)
3.18
1.88
1.70
1.84
1.94
Nonperforming loans(b)
260
286
(d)
372
321
268
(a)
There were no net charge-offs (recoveries) on lending-related commitments in 2008,
2007, 2006, 2005 or 2004.
(b)
Excludes loans held-for-sale and loans at fair value.
(c)
On September 25, 2008, JPMorgan Chase acquired the banking
operations of Washington Mutual Bank. On May 30, 2008, the Bear
Stearns merger was consummated. Each of these transactions was
accounted for as a purchase and their respective results of
operations are included in the Firm’s results from each
respective transaction date. For additional information on these
transactions, see Note 2 on pages 123-128.
(d)
During the second quarter of 2008, the policy for classifying subprime mortgage
and home equity loans as nonperforming was changed to conform to all other home lending
products. Amounts for 2007 have been revised to reflect this change.
Periods prior to 2007 have not been revised as the impact was
not material.
(e)
On July 1, 2004, Bank One Corporation merged with and
into JPMorgan Chase. Accordingly, 2004 results include six months of the combined Firm’s results and six months of
heritage JPMorgan Chase results.
Deposits
The following table provides a summary of the average balances and average interest rates of
JPMorgan Chase’s various deposits for the years indicated:
Average balances
Average interest rates
(in millions, except interest rates)
2008(a)
2007
2006
2008(a)
2007
2006
U.S.:
Noninterest-bearing demand
$
39,476
$
40,359
$
36,099
—
%
—
%
—
%
Interest-bearing demand
13,165
10,737
8,036
0.59
1.31
2.73
Savings
313,939
270,149
260,645
1.13
2.62
2.52
Time
175,117
147,503
126,927
2.74
4.35
3.75
Total U.S. deposits
541,697
468,748
431,707
1.55
2.91
2.68
Non-U.S.:
Noninterest-bearing demand
6,751
6,246
6,645
—
—
—
Interest-bearing demand
155,015
102,959
77,624
2.37
4.71
4.35
Savings
480
624
513
0.58
0.59
0.53
Time
81,864
78,643
60,384
3.00
4.01
3.50
Total non-U.S. deposits
244,110
188,472
145,166
2.51
4.25
3.78
Total deposits
$
785,807
$
657,220
$
576,873
1.85
%
3.29
%
2.95
%
(a)
On September 25, 2008, JPMorgan Chase acquired the banking
operations of Washington Mutual Bank. On May 30, 2008, the Bear
Stearns merger was consummated. Each of these transactions was
accounted for as a purchase and their respective results of
operations are included in the Firm’s results from each
respective transaction date. For additional information on these
transactions, see Note 2 on pages 123-128.
At December 31, 2008, other U.S. time deposits in denominations of $100,000 or more totaled
$93.9 billion, substantially all of which mature in three months or less. In addition, the table
below presents the maturities for U.S. time certificates of deposit in denominations of $100,000 or
more:
The following table provides a summary of JPMorgan Chase’s short-term and other borrowed funds
for the years indicated.
(in millions, except rates)
2008
2007
2006
Federal funds purchased and securities loaned or sold
under repurchase agreements:
Balance at year-end
$
192,546
$
154,398
$
162,173
Average daily balance during the year
196,739
196,500
183,783
Maximum month-end balance
224,075
222,119
204,879
Weighted-average rate at December 31
0.97
%
4.41
%
5.05
%
Weighted-average rate during the year
2.37
4.98
4.45
Commercial paper:
Balance at year-end
$
37,845
$
49,596
$
18,849
Average daily balance during the year
45,734
30,799
17,710
Maximum month-end balance
54,480
51,791
20,980
Weighted-average rate at December 31
0.82
%
4.27
%
4.80
%
Weighted-average rate during the year
2.24
4.65
4.49
Other borrowed funds:(a)
Balance at year-end
$
177,674
$
117,997
$
108,541
Average daily balance during the year
118,714
100,181
102,147
Maximum month-end balance
244,040
133,871
132,367
Weighted-average rate at December 31
3.65
%
4.93
%
5.56
%
Weighted-average rate during the year
4.29
4.91
5.00
FIN 46 short-term beneficial interests: (b)
Commercial paper:
Balance at year-end
$
—
$
55
$
3,351
Average daily balance during the year
3
919
17,851
Maximum month-end balance
—
3,866
35,757
Weighted-average rate at December 31
NA
%
4.38
%
4.67
%
Weighted-average rate during the year
3.23
4.82
4.53
Other borrowed funds:
Balance at year-end
$
5,556
$
6,752
$
4,497
Average daily balance during the year
5,703
5,361
5,267
Maximum month-end balance
7,325
6,752
9,078
Weighted-average rate at December 31
1.13
%
3.04
%
1.99
%
Weighted-average rate during the year
2.69
3.02
1.61
(a)
Includes securities sold but not yet purchased.
(b)
Included on the Consolidated Balance Sheets in beneficial interests issued by
consolidated variable interest entities.
Federal funds purchased represent overnight
funds. Securities loaned or sold under repurchase
agreements generally mature between one day and
three months. Commercial paper generally is issued
in amounts not less than $100,000 and with
maturities of 270 days or less. Other borrowed
funds consist of demand notes, term federal funds
purchased and various other borrowings that
generally
have maturities of one year or less. At December 31, 2008 and 2007, JPMorgan
Chase had no lines of credit for general corporate
purposes.
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on behalf of the undersigned, thereunto duly
authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the capacity and on the
date indicated. JPMorgan Chase does not exercise the power of attorney to sign on behalf of any
Director.